Think the Housing Bubble Was Bad? Check Out These Other Crazy Investment Bubbles
A couple of months ago, an in-law gifted my five-year-old twins a five foot tall box filled entirely with beanie babies. My daughters were thrilled as they sorted through a hundred or so miniature toys. My husband grabbed a pair of scissors and started to cut the tell-tale Ty tags from beanie ears and for a moment I silently screamed "No! They'll be worthless if you cut the tags!"
Of course, beanie babies today are already next to worthless, tags or not. Back in the late 1990s, though, beanie baby collectibles resold for hundreds, even thousands of dollars. There were collector manuals, trade publications, and a proliferation of specialty stores that resold the plush toys in plastic preservation boxes. Parents hoarded the toys, keeping them safe from the grimy hands of their kids. There were more than a few parents who thought their beanie collections would pay for their kids' college tuition. I even owned a few, most notably Peace the Bear who, at one point, was selling for a lofty $200. Sadly, I never cashed in on the capital gain. (See also: How to Create a Speculative Market Bubble and Profit)
Beanie babies are far from the only unpredictable market. Collectible toys, internet stocks, and homes have all fairly recently seen unexpectedly high gains, only to dramatically crash later. Experts overwhelmingly recommend an investment strategy that focuses primarily on a broad-based investment portfolio of diversified assets because history has shown that even the most learned experts can't regularly predict market ups and downs. (See also: 6 Basics You Must Know Before You Start Investing)
Market crashes seem to happen when just about everyone has hopped on a bandwagon and is excited about a particular offering. Let's take a walk through history to see some of the worst timed investments of all time.
Tulips in 1636
The newly imported tulip in 16th century Holland was a popular-yet-expensive addition to many upscale home gardens. It became even more popular after a tulip virus caused the flower's petals to develop beautifully colored stripes in contrasting patterns. A second virus hit the plant, this one lethal, and tulip supply dwindled. The price of bulbs spiked, and soon after, the cost of a single bulb rose to the staggering equivalent of $1,250 (price adjusted for time and currency).
Tulip bulb prices rose steadily from there and soon people stopped planting bulbs and started investing in them instead. At the height of the frenzy, nearly everyone — nobles, farmers, and chimney sweeps alike — were trading in bulbs. People sold off their land, jewels, and furniture to buy more flowers. A good tulip trader could once make the equivalent of $61,710 USD per month, just from trading bulbs. Thanks (or no thanks) to leveraging, tulip options were bought at 15%–20% of actual cost, leading many investors to buy more than they could afford to lose.
How the Tulip Bubble Ended
One day, a merchant didn't show up at market to pay for the bulbs he'd bought. The history books point to this one deal gone sour as the impetus for what became one of the greatest market crashes in history. Tulip owners rushed to sell, prices spiraled down, and widespread panic ensued. Dealers went bankrupt, and soon no one honored their buying commitments. Eventually the Dutch government stepped in and offered to bail contract holders out at 10% of contract value. Even so, prices continued to fall, and eventually everyone in the nation was affected as the market crashed and a long economic depression settled in.
Pretty Much Any British Stock in 1720
In early 18th century England, stock investing for the middle class was a new phenomenon, and many Englishmen were excited to get in the game. There were countless offerings that promised ridiculous business ventures such as trading in human hair, extracting silver from lead, or removing sunlight from a cucumber. Many investors didn't believe in the feasibility of the absurd ventures they funded. They simply thought that stock prices would rise, they'd sell their shares, and they'd profit handsomely from the sale.
Around this time, an unknown man started a company "for carrying on an undertaking of great advantage, but nobody to know what it is." Stock prices were rising to great heights across the country and investors were so excited to get in on the action that when the offering opened, it took just five short hours for a thousand people to invest in the mysterious investment.
The largest investment opportunity gone awry during this time was the South Sea Company, which was founded to conduct trade throughout the South Seas. The company's stock rose from an initial offering price of 130 to more than 1,000 pounds per share, even though none of the company's directors had any experience in South American trade.
How the South Sea Bubble Burst
The directors and officers of the South Sea Company realized that the company's share price was heavily inflated and so sold their holdings. The general investing public heard of the sale, panicked, and sold their shares at increasingly lower prices. The British public credit system almost collapsed, and as a result, it was more than 100 years before it was again legal for a company to issue public stock. Oh, and the man with that mysterious stock offering? He closed the issue at the end of that first day and promptly sailed off for America. No one ever heard from him again.
Internet Stocks in Early 2000
Personal computer growth exploded in the early 1990s, followed by multiple web browser developments, bringing the mass public online for the first time ever. Internet upstarts proliferated as companies rushed to profit off nascent Internet traffic. The only hitch was that many tech companies had yet to figure out how to make a profit in the online world.
This technicality didn't matter to investors, though, who regularly overlooked traditional metrics and invested at staggering price-to-earnings ratios on the assumption that technological advances would far outpace the growth of a company's stock price. One such profit-less company, TheGlobe.com, ended a five-day IPO at a 249% gain over its initial target price.
Excitement heightened as established companies and upstarts alike rushed to cash in on the tech boom. Some created new and exciting online businesses while others did little more than change their corporate name by adding a .com suffix or an e- prefix. Internet giants Amazon.com, eBay, and Google were founded during this time, but so were the now defunct and long-forgotten Pets.com, e-Stamp.com, e1040.com (notice the tell-tale prefixes and suffixes). The NASDAQ rose by more than 700% on a cumulative basis in the 10 year decade before the bubble eventually burst. (Note: the NASDAQ has yet to return to its year 2000 peak.)
How the Internet Boom Ended
By the end of the decade, there was a new IPO issued almost every day, and day trading seemingly became a new national pastime. Tech companies were unable to keep up with market expectations and some, like WorldCom, were later found to be cooking their books in an effort to keep the party going. A majority of tech companies didn't survive the crash, but even those that did saw significant drops in stock price (e.g., Amazon saw its stock price fall from $107 to $7 per share). In the end, over $5 trillion in market value was lost in the crash between 2000–2002. The following years from 2000–2009 became known as "the lost decade" as stock market returns were unprecedentedly low.
U.S. Real Estate in 2007
Housing prices skyrocketed in the early part of this century and it seemed that prices would never level off. Around this time I had a marketing professor ask his class of graduate students to raise their hands if they owned a home. "If your hand isn't raised," he told us, "you'll never own one. Prices are going up too quickly and they aren't coming down." This was pretty much what everyone thought about homeownership at the time.
The overinflation of the housing market became even more evident in 2005 when then-Fed chairman Alan Greenspan said that "at a minimum, there's a little 'froth' (in the U.S. housing market)… it's hard not to see that there are a lot of local bubbles."
How the Housing Boom Ended
Housing prices peaked in 2006 before a dramatic drop in the market left many homeowners owning homes that were worth far more than they had paid. In 2008, the Case-Shiller home price index reported its largest price drop in history. Many experts believe the burst housing bubble was the primary cause of the 2007–2009 U.S. recession. By the end of 2010, 23.1% of all U.S. homeowners held negative equity in their homes. (See also: 6 Options if You're Underwater On Your Mortgage)
Avoiding the Bubble
It might be tempting to try to cash-in on an inflating bubble, but it's impossible to predict how any one investment will perform over time. Those who try inevitably lose. Don't risk losing all your assets in the next best thing. Take the advice of the overwhelming majority of wealth managers and create a diversified portfolio strategy, and rebalance your mix of stocks and bonds often. Check out The Basics of Asset Allocation for a primer.
Have you ever lost money on tech stocks, beanie babies, your home, or another market bubble? How did that loss affect your investment strategy? Tell us about it in the comments below.