Most of us have heard “Buy low and sell high!” That’s easy to say but frequently difficult to follow. It can, however, be a key principle to making money. Think of “tulip mania” in 17th century Holland:
In the mid-1600s, the Dutch enjoyed a period of unmatched wealth and prosperity. Newly independent from Spain, Dutch merchants grew rich on trade through the Dutch East India Company. With money to spend, art and exotica became fashionable collectors items. That’s how the Dutch became fascinated with rare “broken” tulips, bulbs that produced striped and speckled flowers.
First these prized tulips were bought as showy display pieces, but it didn’t take long for tulip trading to become a market of its own. Tulip prices spiked from December 1636 to February 1637 with some of the most prized bulbs, like the coveted Switzer, experiencing a 12-fold price jump. While tulip mania didn’t destroy the Dutch Economy it did cause quite a stir. “Tulips were something that was fashionable, and people pay for fashion,” says Goldgar. “The apparent ridiculousness of it was played up at the time to make fun of the people who didn’t succeed.”
“The Real Story Behind the 17th-Century ‘Tulip Mania’ Financial Crash,” History Stories, history.com
People like to talk about what they are doing and why they are smarter and more successful than others. Experience has taught me that people make money in all kinds of economic circumstances. Markets go up (bull market), markets go down (bear market) and pigs get slaughtered (allowing the latest mania) to influence your buying.
Following the Herd
Illustrating the herd mentality were the buffalo hunts of the Native American Plains. To hunt buffalo, Native Americans employed specific strategies like the buffalo jump.
This involved luring buffaloes to a precipice and manipulating them into a stampede past the land’s end where they fell to their death.
This endeavor involved a large part of the tribe. A nimble and quick man, dressed as a buffalo with horns and a hide-like robe, led the buffalo to the jump site while others surrounded the buffalo and scared them using blankets and tactics to guide them in the right direction.
Investing has often been done in similar fashion by investing, or stampeding, towards what everyone else is doing or talking about. When everyone is buying and prices are accelerating far beyond replacement value, it is time to pause.
Spend it, Loan it, Invest it
To keep things simple there are only three things you can do with your discretionary savings.
Spend it, loan it to the bank or others for interest, or own part of the American economy in the form of stock, real estate, or your own business. Loaning your money to a bank is relatively risk-free. Therefore, it pays the least amount of interest. Owning part of the American economy, or any economy, is a higher risk and will offer a greater return. Buying a piece of the economy in the form of investments gives you the opportunity to own a part of the companies that produce the goods and services people need to live, survive, and flourish. Remember—those that spend and borrow to live usually work for those that lend or own. Are you a lender or a borrower? Are you a renter or an owner? Are you a consumer or a saver? Owning assets like a small business, real estate, stocks in companies producing goods and services, like food, health care, leisure, energy, etc. will give you a chance to stay ahead of inflation.
July 15th, 1924, in Boston, the first pooled investment company was established for $50,000. Known as Massachusetts Investors Trust, it became America’s first mutual fund. A mutual fund is an investment vehicle that pools small to large amounts of money from many investors with a common investment objective such as safety, income, growth, or a combination. The money is then invested in various asset classes like stocks, bonds, real estate, or money market funds based on the fund’s objectives. An asset management company like Vanguard, Fidelity or American Funds makes these investments on behalf of the investors for a fee. Because you are investing in owning a portion of companies like Apple, Amazon, Google, Netflix, Bank of America, Wells Fargo, Chevron or Shell Oil, Costco, Walmart, Tesla, McDonalds, etc. you effectively own a little piece of companies that are usually exceeding the rate of inflation because of the products and services they offer. They typically supply what are perceived as necessities.
How to Invest
Time has demonstrated three things.
First, timing the market (speculating) for the lowest point and selling at the highest is rarely possible or successful. What is probable is that it matters more that you actually begin to invest rather than wait for a bottom to start.
Second, a sound strategy is to use dollar cost averaging. With DCA you start investing the same amount of money at regular intervals (weekly or monthly). As an example, if you invested $100 per month when the stock market is high, at say $100 a share, you will buy one share. If you invest the next month when the price drops to $1 your $100 will buy 100 shares. If the stock market then gains back 50% of its value, your loss or $5 a share from the first month, you will buy 20 shares. Let’s now summarize. You now own 121 shares at $5 or $605 from your original investment of $300, or about a 100% gain. I have exaggerated the swings to illustrate this true principle. However, if you regularly save money this way you will buy more when prices are down and less when they are up. DCA will also reduce the volatile swings of the market and decrease your risk. Ultimately you will be a successful saver and investor.
Third, one of the 10 wonders of the finance world is known as compounding money. As you leave your money invested, your money will make lots of babies in the form of additional interest. As an example, $1,000 invested at 8% (the stock market and real estate markets have years earning much more or even losing much more) for 10 years would be worth $2,159. The same $1,000 in 20 years would be worth $4,661, in 30 years $10,063, in 40 years $21,725. Notice that this is not a linear growth but a compounding of money building on top of prior years.
You too can be a multi-millionaire if you will save regularly when you begin working and earning money. If you save $125 per month at 8% starting at age 16 to the age of 66 you would have about $1 million dollars. If you wait 10 years to begin saving that savings would be $436,375 or lost money of over $500,000 for waiting 10 years! One last thought, if you invest $125 per month beginning at age 16 in large capital stocks the historical rate of return has been about 11%, not 8%. The value at 66 would be over $3 million dollars!
Key lessons for becoming financially independent and beating inflation:
- Start saving as much as you can now (save at least 10% or more of what you earn).
- Invest in the American economy or other economies where freedom flourishes.
- Sound investing is not gambling. Prudent investing is owning an asset (real estate, stock, or small business) of value; through time and foresight that asset becomes worth more.
- People will always need shelter, food, fuel, heath services, etc.
- Gambling is not investing in an asset, it is speculating on non-assets like cards, dice or numbers randomly aligned with your opinion.
- Speculation may be a part of investing but only if it is in assets like gold, silver, and commodities. However, remember you may be risking your money on guessing about events you have little to no control over. The closer you stay invested in necessities people must have the lower your risk will be. Never allocate more than 5-10% into speculation.