Sir Isaac Newton
Isaac Newton is rightfully considered one of the greatest scientists of all time. He developed the three laws of motion and is credited for building the first working reflecting telescope. To say he was smart is like saying Peyton Manning could play quarterback.
Newton, though famous for his brilliance, was also famous for losing significant wealth in the stock market, specifically in shares of the South Sea Company.
The South Sea Company was established in the early 18th Century and granted a monopoly on trade in the South Seas in exchange for assuming England’s war debt. Needless to say, investors found this monopoly appealing and quickly began bidding-up its share price, eventually making this stock the most popular in England.
Isaac Newton, having already owned shares in the South Sea Company, watched the company’s stock price rise exponentially. As a result, he famously said, “I can calculate the movement of stars, but not the madness of men.” Newton soon realized that stocks don’t trade on fundamentals; they trade on expectation and sentiment. Though Newton sold his shares for a handsome profit, his observations didn’t stop him from jumping back in at a higher price. From there, he lost what would today be worth millions of dollars. Supposedly, he forbade anyone to say “South Sea” in his presence for the rest of his life.
Personal finance has certainly evolved over the last 300 years; however, behavioral finance is still the same. Our human emotions largely determine our experiences with money. Warren Buffett’s mentor, Benjamin Graham, said, “For indeed, the investor’s chief problem – and even his worst enemy – is likely to be himself.” Newton may have been a great scientist, physicist, and mathematician, but much like you and me, he faced the same emotional challenges when it came to money.
So if Newton were alive today, this is what I would share with him:
• It’s possible to get rich owning many shares of one company, but it’s probable owning a diversified portfolio of stocks would be more beneficial. Research has shown that since 1980 investors were likely to make more money investing in an index fund that tracks the Russell 3000 than in a single stock.
• If you must own stock of one company, limit it to no more than 10% of your total net worth and certainly no more than 5% of your liquid net worth (cash, CD’s, stocks, bonds, mutual funds, etc.).
• If you already own a large amount of stock in one company relative to your goals and net worth and find it hard to sell due to capital gains or even an emotional attachment, then find someone (like a family member or friend in need) or something (like a church, charity or trust) more important to you than those shares and give some to them. They might be able to sell them at a lower capital gains rate or even tax-free.
Benjamin Graham also said “Individuals who cannot master their emotions are ill-suited to profit from the investment.” A good starting point to becoming a successful investor is to remember that success in one area of life does not automatically lead to success elsewhere even if you did invent calculus.