Interesting Questions:
Market Mania
When smart people make bad investments
Isaac Newton's experience with the South Sea Company in 1720 is one of the most famous examples of a brilliant mind falling victim to market mania. His investment happened in two distinct phases: one driven by logic and the second driven by emotion.
How Isaac Newton screwed up
Normally I have an extended dialog with AI. Here I just asked AI to recap Newton's investment experience.
Al: Isaac Newton's big mistake
"The disciplined exit
In early 1720, the South Sea Company's stock began to rise rapidly. Newton, an early investor, watched the price climb and decided to take his profits while he was ahead.
Action: he sold his shares in April and May of 1720.
Result: he walked away with a profit of roughly £7,000, doubling his initial investment. At this point, Newton had played the market perfectly.
The fomo re-entry
After Newton sold, the stock didn't crash — it kept skyrocketing. He spent the next few months watching his friends and peers get “paper rich” as the price moved toward £1,000 per share. The social pressure and the sight of others making “easy money” eventually broke his discipline.
Action: in June 1720, at the absolute peak of the bubble, Newton jumped back in with a much larger sum of money than his first investment.
i: he bought in when the stock was at its most expensive, fueled by the “fear of missing out” (fomo).
The crash and the aftermath
The bubble burst shortly after his second entry. By September, the stock price collapsed. Because he had doubled down at the top, Newton lost an estimated £20,000 — which would be worth several million dollars in today's currency.
Famous last words
“I can calculate the motions of the heavenly bodies, but not the madness of people.”
— Isaac newton
A lifetime of regret
Newton reportedly became so sensitive about the loss that he grew angry if anyone even mentioned the words “South Sea” in his presence for the rest of his life."
My response
Oh the temptation
It's hard to sit out a stock market melt-up, if that's what you personal investment plan dictates.
But when (not if) there's a market correction, you could take a big hit. The damage could be very inconvenient, if not catastrophic — if you need that money anytime soon.
Investing vs. speculating
Investing is long term. You're willing to ride out the inevitable up and down stock market cycle — which is separate from the ups and downs of a particular stock. This is money you're prepared to leave invested for at least five to ten years. It's money you will only tap into for emergencies. Most important, it's money you aren't willing to gamble.
Speculating is short term. Speculating is gambling. If you win, you can make a lot of money, and perhaps do so quickly. But you accept the risk of losing.
What's scary about market melt-ups is the crazy risks inexperienced "retail" investors take. Just a few examples:
Gamble money needed to live on.
Use margin — borrowing money from your brokerage firm to buy more stock than you could afford with your own cash alone, using your existing investments as collateral.
Borrow against fixed assets like houses, business, etc.
Cash out life insurance.
Here's the thing
The stock market is rigged to screw short term retail investors. That will be the topic of another blog post. Suffice it to say that even if you're Isaac Newton level smart, jumping into a melt-up is like skate boarding on a busy freeway. IMHO.