Isaac Newton was one of the greatest minds of all time. However, there is a significant difference between being a brilliant physicist and being a smart investor.. Newton, regrettably, discovered this the hard way. There’s a tale of how famed physicist Isaac Newton lost a packet during the so-called “South Sea bubble” of 1720, and it’s one of the many famous financial anecdotes. To rub salt in the wound, Newton had made a profit on that investment by cashing out early before succumbing to greed. Newton turned a profit of £7,000 when he liquidated all of his South Sea shares, according to Wall Street Journal’s Jason Zweig, who published an upgraded version of Benjamin Graham’s 1949 classic, “The Intelligent Investor.”
Newton popularly remarked that he could compute the motions of the celestial bodies, but not the craziness of the people, in response to a frantic public bid for shares. But, as the share price kept rising a few months later, Newton couldn’t avoid the temptation of making even more money and bought shares at a much higher price. He wasn’t as fortunate this time. He lost £20,000 (about $3 million in today’s value) in 2002-03. Many have contested this narrative, with some, such as economist John Maynard Keynes, claiming that Newton made a profit on his second effort as well. It’s impossible to say if Newton profited or lost money, but the recent surge in some equities has some market analysts seeing comparisons with the 1720 South Sea bubble.
Sir Isaac Newton was forced to make a choice in early August 1720. Should he sell the last of his secure savings to acquire shares in the South Sea Company in a year when London’s stock market was surging skyward in an entirely unparalleled boom? Since January of that year, shares in the company, one of the world’s biggest private companies, had increased eightfold, making thousands of people rich on paper. Newton, who was already well-off, was a prudent investor. Much of his money was stashed away in various types of government bonds before the year began—reliable, unremarkable investments that provided a steady supply of income. He did possess stock in a handful of the exchange’s major companies, notably South Sea, but he was never a quick or keen market trader. That had changed in recent months, as he purchased and sold into the hot market, apparently with the intention of turning a modest fortune into a massive one.
By August, he’d sold the majority of his bonds and converted the rest of his holdings into South Sea shares. He was now considering selling the remainder of his bonds in order to buy additional stock. He was able to sell almost all of them. It was a terrible decision. The market shifted in three weeks. It had completely crashed by Christmas. In today’s money, Newton’s losses amounted to millions of dollars. It became the first stock market “bubble,” and even Isaac Newton became swept up in the frenzy.
The South Sea Bubble
One of the first major market crash stories is that of the South Sea Company, a publicly-traded company created in 1711 to trade with Spanish South American possessions. The South Sea Company’s shares soared from £128 to £1050 between January and June of that year. They were worth £175 again by September. The term “bubble” was first used in connection to publicly traded firms that year. In fact, according to Richard Evans of The Telegraph, 1720 was known as the “Bubble Year.” “Newly floated firms were seen as appearing like bubbles,” Evans adds, owing to the popularity of the South Sea Company. However, all of the bubbles eventually burst.
The Bubble Act was passed by Parliament in June 1720. All firms that sold shares to the general public were obliged to have a royal charter. Isn’t it sounding like it could help with the overabundance of speculation? However, there was a snag. The South Sea Company had introduced the legislation, apparently to limit competition in the rapidly growing sector. The charter of the South Sea Company was considered as a show of faith in the company, and shares continued to rise. Early in July, investors began to lose faith. The bubble had burst by September, investors had lost the majority of their money, and the public was furious.
The director of the company had spread fake claims of accomplishment and extravagant tales of South Sea riches, according to a report produced on this day in 1921 by a Parliamentary committee tasked with investigating the subject. Officials from the government have also been implicated. Many of them showed up in the trials that followed. What happened to Newton during all of this? It appears that there is a lot of selling and purchasing going on. He once said, “I could calculate the motions of the heavenly bodies, but not the madness of the people,” according to a quote ascribed to him from this time period. Newton sold his South Sea shares early in the year for a profit of £7000, a 100 per cent gain. But, caught up in the market’s craze, Newton returned a few months later at a much higher price—and lost £20,000 (about $3 million in today’s money). He refused to listen to the words “South Sea” in his proximity for the rest of his life.
Newton was definitely not a fool. He theorized his three laws of motion and developed calculus. However, this story illustrates that he was not a wise investor since he allowed his emotions to rule him and was misled by the stupidity of the herd. Or, as Graham put it, “For indeed, the investor’s chief problem — and even his worst enemy — is likely to be himself.”
Any investor is capable of making blunders. Newton, on the other hand, was no average loser. He was the world’s finest mathematician, someone who spent a lot of time thinking about change through time, risk, and the computations that transformed the experience into numbers. This other Newton—not the incomprehensible brilliant man, but the player who failed—has an incalculable number of heirs. The international financial system continues to fail in the same manner as it did 300 years ago. The dot-com bubble, which burst between 2000 and 2002, and the real-estate bubble, which burst between 2007 and 2008, were both part of a repeating cycle of boom, bust, and bankrupted individuals, companies, and countries. Newton’s mistakes are important because we continue to make them.