Investing

Investment Lessons from Two Towering Intellectuals

Most people have heard about the towering intellectuals Sir Isaac Newton and Benjamin Franklin who were born in the 17th and 18th centuries respectively but left an indelible mark in our lives several centuries later. Most school kids are required to learn Newton’s three laws and it is hard to forget that if you punch the school bully, you are likely to experience (at least) an equal and opposite reaction.

What a lot of folks don’t know is that both of them were polymaths and had varied interests that spanned several fields. They were both scientists and authors but also had a good grasp of finance and investing. Sir Isaac Newton went on to become the warden of the Royal Mint in England as well as the Master of the Mint and stayed in that position for 30 years until his death. Benjamin Franklin helped several of the newly formed colonies in America print their currencies and his printing operations helped him retire at the ripe old age of 42.

A couple of their financial escapades that resulted in opposite outcomes provide some interesting investment lessons. Financial bubbles have occurred over the centuries in various countries across diverse asset classes. The dutch tulip mania that gripped the citizens of Netherlands resulted in the price of tulip bulbs rising to astronomical levels before crashing in February 1637 with devastating consequences for most speculators.

More recent bubbles include,

  • the Japanese asset price bubble from 1986 to 1991 that saw the price of both real estate and stocks soar to unsustainable levels
  • the U.S. dot com bubble from 1998 to 2000 that resulted in the Nasdaq stock index peaking near the 5,000 level
  • the U.S. housing bubble that peaked in 2006  and
  • the cryptocurrency bubble that saw the price of bitcoin drop 65% in just the first two months of 2018 after going up several thousand percent.

One such bubble that occurred in the early eighteenth century was the South Sea Bubble that saw the stock of the South Sea Company rise from £128 in January 1720 to £550 at the end of May before coming back to earth. Sir Isaac Newton got sucked into this bubble and lost a considerable sum of money. He initially got into the stock, watched his original stake double and sold it for a profit.

To his dismay, the stock continued higher after he sold it and everyone around him appeared to be making money trading the South Sea Company stock. He got caught up in the wild enthusiasm for the stock and got back in at a much higher price. The collapse of the bubble is purported to have cost him over £20,000 or the equivalent of over $3 million in today’s money. After his experience with the South Sea Bubble, Sir Isaac Newton has been quoted as saying,

“I can calculate the movement of the stars, but not the madness of men”

In 1790 Benjamin Franklin set up two trusts for the cities of Boston and Philadelphia and left 1,000 pounds sterling to each city with instructions about how that money could be used and when it should be distributed. While 1,000 pounds sterling might not seem like much, it is estimated to be the equivalent of $4,000 in 1790 and after adjusting for inflation, well over $1 million in today’s money. He left instructions that the money from the trusts should be used to make small loans to artisan entrepreneurs at a 5% interest rate. After 100 years, he wanted the two cities to use a large portion of the trust for public projects and invest the rest over the next 100 years. At the end of the 200 year period, he wanted the remaining money to be distributed to the two cities. A portion of the funds would also go to the states of Massachusetts and Pennsylvania.

By 1888 the Philadelphia trust had grown to $72,819 but the Boston trust fared better and had grown to $$368,741 by 1890. Both cities used a large portion of the trust to set up education institutions including the Franklin Institute of Technology in Boston and the Franklin Institute in Philadelphia. The rest of the money was invested and by 1990, at the end of the 200 year period, the Boston trust had $4.5 million and the Philadelphia trust had $2 million. The wide variation in the ending values of both trusts had to do with how they invested the money during that 200 year period. Boston only got to 66% of what Franklin assumed the trust would grow to by 1990 and Philadelphia fared much worse with their trust ending up at just 33% of Franklin’s goal. Despite the mismanagement of funds, the lawsuits from Franklin’s heirs attempting to break up the trusts and challenges related to distributing those funds, the trusts did grow to substantials amount of money and benefited a large number of people along the way.

When it comes to investing slow and steady returns compounded over a long period of time can generate sizable sums of money compared to attempts at capturing the ecstacy and madness of bubbles. There are always exceptions to rules and the hedge fund billionaire George Soros’ approach of capturing the middle part of bubbles has worked well for him but is a very dangerous way of investing hard earned capital. For most investors the Benjamin Franklin method of planning for the long run and letting the power of compounding work for them can create wonderful results.

Sources:

NY Times: From Ben Franklin, a Gift That’s Worth Two Fights

Historynet: Ben Franklin’s Gift that Keeps on Giving

Chris Carosa: Ben Franklin Trusts – Did They Work?

Manias, Panics, and Crashes: A History of Financial Crises by Charles P. Kindleberger and Robert Z. Aliber

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