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Bubbles Burst When People Invest in Symbols

One of the best things I ever did was read Wall Street: A History: From Its Beginnings to the Fall of Enron by Charles R. Geisst [3]. In it, I learned about the famous tulip bulb craze in 1630s [4]. During that craze, people were buying exotic colored tulips like they were going out of style (which they soon would) and many folks ended up with little more than a couple pretty flowers (check Wikipedia for the full scoop).

Let’s compare that with the dot com bubble and the housing craze and see if there are any similarities. In the dot com boom, investors were putting money into companies that were little more than an idea and a URL. In the tulip bulb boom, someone was able to sell shares in a company that claimed to one day be involved in the trading of tulip bulbs (this is based on my memory of what was included in Geisst’s book, there’s no mention of this on the Wikipedia page), only to run off with the money. In the housing craze, people were given 100% LTV loans based on the magic lenders were able to make in the books and not based on the borrower’s actual ability to pay (in this case, the lender was the investor). So in all three cases, the bubbles formed because people were so greedy that they invested in the “symbol” and not the fundamentals.

The lesson here is that you shouldn’t let greed cloud your judgments. Remember that Rule #1 is “don’t lose money.” Warren Buffett is plenty rich and he basically skipped the dot com boom. Some had written him off because he missed it but he said that he was just fine. Buffett only invests in things he can understand. He couldn’t understand why people were paying these ridiculous valuations for companies that had zero earnings.

So, the next time you see people acting all crazy (how many people told you to invest in a hot stock or to buy a house because it can’t do anything but go up?), don’t jump in. Watch from the sidelines and you’ll save yourself a lot of money.

(Photo: powi [5])