Too Smart to Make Investing Mistakes?

by Paul R. Ruedi, CFP®

A genius physicist and mathematician, Sir Isaac Newton had a profound impact on our understanding of the world. You would be tempted to think this intelligence would have translated to an equally genius investing career, but this is actually far from the case.

In his paper, Newton’s Financial Misadventures in the South Sea Bubble, Professor Andrew Odlyzko of the University of Minnesota School of Mathematics looks at the historical record of Newton’s investing decisions. As the title of the paper implies, things didn’t go particularly well for Sir Isaac.

Newton, like a lot of smart and wealthy people at the time, experienced a wild ride investing in the hot stock of the day: a global trading company called the South Sea Company. His investing career started off well. Newton invested in the company back in 1712, long before the company’s stock price saw explosive growth in 1720 and increased roughly 5-fold in just a matter of months amongst a sea of investor enthusiasm. He even sold most of his shares at that time and made a very hefty profit.

Had Newton been disciplined enough to just walk away and enjoy his profits, we would be telling a very different story today. But after Newton sold his shares the price of South Seas Company stock doubled in two weeks. The fear of missing out overcame Newton and in a panic he bought back in at twice the price he had recently sold his shares for. When the price rose another 8%, instead of taking his winnings he bought even more.

Like many companies whose stock prices experience a rapid rise in a short time due to investor euphoria, the price of the South Seas Company stock eventually crashed and took Newton’s investment portfolio with it. Odlyzko suggests his losses were as high as 70%. He remained a wealthy man, but only because he was wealthy before investing.

The whole ordeal affected Newton profoundly. He supposedly could not bear to hear about it for the rest of his life. It famously caused him to say, “I can calculate the motion of heavenly bodies, but not the madness of crowds.”

Moral of the story, if even a genius like Sir Isaac Newton can get swept up in an investor mania and fall victim to his own emotions, then clearly no amount of intelligence can guarantee against investing mistakes. If you think you are simply too smart to make a bad investment decision, you should probably think again.

Paul R. Ruedi is a Certified Financial Planner™ professional with Ruedi Wealth Management in Champaign, Illinois.