Investment mistakes and lessons from history

In simple terms

Every generation of investors meets new products and new technologies, but the mistakes are old. People borrow too much at the top, put too much in one thing, chase whatever has risen most, and tell themselves that this time is different. Market history is a record of the same behaviour in new clothes.

This lesson looks at the patterns, with examples clearly tied to their periods. They are history, not predictions.

The pattern of a bubble

Many bubbles have followed a similar path:

1. A real story: a new technology, a booming economy, or a genuine change.
2. Rising prices attract attention and early investors make large gains.
3. New investors arrive, often with borrowed money, driven by fear of missing out.
4. Valuation is dismissed: "the old rules no longer apply".
5. Buyers run out, prices fall, borrowed money forces sales, and the fall feeds on itself.

The story is often partly true. The mistake is paying any price for it.

Dated examples from history

• The Dutch tulip episode, 1630s: prices of some rare tulip bulbs in the Dutch Republic rose to extraordinary levels before collapsing in early 1637. Historians still debate how widespread the losses were, but it became the classic tale of speculative excess.
• The South Sea Bubble, 1720: shares of Britain's South Sea Company soared on promises of trade profits, then collapsed within months, ruining many investors.
• The 1929 crash, United States: many investors had bought shares with borrowed money. The Dow Jones Industrial Average fell by close to 90% from its 1929 peak to its 1932 low, and took about a quarter of a century to regain that peak, which it did in 1954.
• Japan, late 1980s: share and property prices rose to very high valuations. The Nikkei 225 peaked at the end of 1989 and took more than three decades to regain that level.
• The dot-com bubble, late 1990s: internet company shares rose on the promise of a new economy. The Nasdaq Composite lost more than three-quarters of its value between its peak in March 2000 and its low in October 2002. The internet did change the world; many of the companies did not survive.
• India, 1992: a sharp rise in share prices, fuelled partly by money improperly diverted from the banking system, ended in a crash when the securities scam was exposed in April 1992.
• The global financial crisis, 2007 to 2009: heavy borrowing tied to US housing spread losses through the world's financial system. India's Sensex lost more than half its value between its January 2008 peak and its lows later that year.

In several of these episodes, broad markets later recovered, as the bull and bear markets lesson describes. But recovery took years or decades, many individual companies never recovered, and investors who were forced to sell did not share in it.

Leverage at the wrong time

Borrowing to invest multiplies results in both directions, as the leverage entry explains.

The danger of leverage is not only larger losses; it is losing control of when you sell.

Concentration

Many investors have lost most of their wealth in a single company: often their employer, a famous name, or a company they were sure about. Even large, respected companies have failed. Concentration turns one company's problem into a personal disaster, as the diversification lesson explains.

Chasing past returns

Money tends to flow into funds, sectors and assets after they have done well, as the herding and recency lesson shows. Investors buy the past and own the future. Last decade's winners have often not been the next decade's.

"This time is different"

Each bubble comes with reasons why old valuation rules no longer apply. Sometimes things really are different in some ways. But the claim deserves extra scepticism when it is used to justify paying any price.

Why it matters

The investors hurt worst in history were rarely those who lacked information. They were those who borrowed too much, concentrated too much, or bought because prices had risen. These are choices, and they can be avoided by following a plan, keeping leverage low or zero, diversifying, and judging decisions rather than outcomes, as the decisions and outcomes lesson explains.

Limitations

Historical episodes are complex, and summaries simplify them. Examples are chosen because they were dramatic, which can make crashes seem more frequent than they are. Past recoveries do not guarantee future ones, and future crises may look different from past ones.

Common mistakes

• Believing you will spot the top.
• Borrowing to invest in a rising market.
• Holding most of your wealth in one company.
• Assuming any fall will recover quickly.

Try it yourself

1. Read a detailed account of one episode above and list which of the five bubble stages you can see.
2. Check whether any of your holdings is more than a tenth of your portfolio, and why.
3. If you use any borrowed money to invest, work out what a 30% fall would do to your own money.
4. Write down one popular investment idea today and what would have to be true to justify its price.