Tulip Mania, Recency Bias and Portfolio Management

One of the first known financial bubbles was known as Tulip Mania. It occurred during the 17th century when the Dutch Republic was one of the world’s leading financial powers. During this period, irrational human behavior took hold of the Dutch population regarding tulip bulbs which caused extreme price speculation. Beginning in 1634, the acceleration of tulip prices blossomed and significantly deviated from the true worth of the bulb itself. As strange as this sounds now, depending on the rarity of the tulip bulb variety, bidders were paying as much as $200,000 in today’s U.S. dollars for a single bulb. By 1637 the speculative tulip bubble drastically collapsed, and traders could no longer find new buyers willing to pay irrationally inflated prices.

The aftershock of tulip mania was considerable and caused the perceived value of other goods and services to be cast in doubt. The idea that prices on a flower that only bloomed once per year could increase without legitimate rationale and then come tumbling down, interfered with the fundamental valuation of other assets. It also caused a decrease in overall economic activity as consumers and businesses postponed spending and investment in anticipation of further widespread price declines.

This cognitive distortion known as recency bias causes the mind to overemphasize current events when making decisions, often adopting overly optimistic or pessimistic outlooks even when rational long-term trends suggest otherwise. We experience recency bias even today when investors recall recent market movements more vividly than older information. For example, when markets experience losses, it often leads an investor to overestimate the severity and length of future market movements. After a market downturn recency bias may have investors hyperfocused on the freshness of losses leading to the interpretation that the market is fated to further losses, which we rationally know is not a valid conclusion.

After the Tulip Mania, many Dutch citizens were hesitant to make other investments due to the recency bias of the tulip crash. While the overall Dutch economy did not collapse, the impact of the tulip price collapse had a psychological impact, and consumers shifted to more cautious investment spending. Afterwards it was evident that taking a broader, more informed view of the market’s potential was the healthier outlook.

Tulip Mania and recency bias teach us valuable lessons about market irrationality, the dangers of speculation, and the importance of sound financial decision-making. Recency bias can lead to poor decision making in markets and investments by ignoring long-term trends and sound analysis. Extreme speculation can lead to unsustainable prices, irrational behavior, and poor long-term outcomes. At Greenleaf Trust we believe in diversifying your investments to reduce the impact of any single asset or market trend. Our investment decision-making is built on accepted principles and empirical data fundamentals. We maintain a long-term and disciplined approach which leads to improved investment outcomes over time. It is the development of a sound financial plan with your Greenleaf Trust client centric team that provides peace of mind to weather manias, economic cycles, and market pressures.