How To Tell If An Investment Trend Is Just A Fad

Though you’d never know it given the current financial division of power in Europe, the Netherlands were a financial powerhouse in the early 17th century. The Dutch are often credited with establishing the first global financial markets, investing in colonial trading ventures (or, more accurately, investing in the looting of colonized lands.) The emergence of Dutch financial markets provide one of the first historical examples of the sort of globalized financialization that characterizes the current momentum of international investing, and as a consequence, Dutch financial markets were often provided the first example of financial events that we see happening now.

Unsurprisingly, then, one of the first global financial bubbles in the historical record happened in Holland in the 1630’s: tulip mania (or as it was called at the time, tulpenwoede.) Looking at the “tulip fever” can give us a good historical perspective on a question at the forefront of every modern-day investor’s mind:

How can you tell if an investment trend is just a fad?

The tulip mania was an investment fad in which the price of tulip bulbs skyrocketed rapidly. At its peak in 1637, one tulip bulb could be traded for 12 acres of farmable land in the Netherlands—a geographic location in which arable land was very dear indeed. The tulip was introduced to Europe through Turkey, and rapidly became a symbol of luxury because of its utter uniqueness in Europe—no other flowers were like it. The Dutch secured some of the bulbs, and began producing them in a very limited fashion—one bulb can take 7-12 years to grow from a seed. This meant that only a small number of tulips were available, making competition fierce to secure these luxury goods. As a result, people began investing with bulbs as their security. Suddenly, tulip bulbs were not only a commodity, but were also a form of currency. With the crash of the tulip bulb market in the 1640’s, many investors were ruined, and everyone started to wonder what the hell had just happened in these nascent financial markets.

So what can we learn from the tulip mania?

1. An investment fad is hard to tell apart from an investment trend because of the way financial markets work.

Like any market, things are only worth as much as people are willing to pay for it. As any inventor can attest, you can have the most magnificent idea in the world, but it’s worthless if nobody wants to buy it. Items acquire value when a community decides that the item is valuable. In a fad, this happens very quickly. This doesn’t mean that the item isn’t valuable—after all, value is just how much people are willing to pay for the item—but that value is going to be mercurial and unstable.

2. An investment fad is marked by items that are more valuable for trade than for use.

Remember that the tulip bulb craze didn’t “blow up” until the bulbs started to be used as currency in addition to being used as commodities. People were no longer planting the bulbs—that would have been crazy, given how valuable they were. Rather, they were investing with the bulbs as security. The only thing backing the bulbs was the collective confidence that the bulbs would continue to be valuable. This should sound familiar, since it was exactly this dynamic that rendered CDO’s suddenly worthless in the global 2008 economic collapse.

Neither of these principles means that you can’t make money off of an investment fad—many people made fantastic amounts of money off of both the tulip mania and the 2008 crash. But the people who made money were trading in the precarious currency (tulips or bad securities), not hoarding the items. Just like it would be a terrible idea to hoard currency that is going to rapidly and unpredictably devalue, then, you don’t want to hold on to fad investments that are going to rapidly devalue. The trick is to get in on the investment fad and trade those temporarily—valuable items for items that will not devalue rapidly.