Throughout most of human history wealth creation, accumulation, and investing has been centered around acquisition of physical items. Most of our ancestors would consider investing in modern securities as exotic and a risky alternative to traditional ways of preserving and growing wealth. Tangible and portable assets like gold and jewelry inspired confidence by their appearance, rarity, and ability to store value. Treasures and land were the preferred investable assets, as well as a store of value and means of increasing wealth. Once wealth was acquired, it needed to be deployed, so capital worked just as hard as the owner who acquired it, but making that happen efficiently did not happen until the advent of liquid security markets, and the risk was often disproportionate to any possible rewards. In order to understand why the current view of the stock market as a safe and traditional investment is potentially flawed, we need to go back in history and see just how volatile and unpredictable this asset class has been.
Investing, as a means of growing wealth, is as old as human civilization. The history of investing can be traced back to the famous Code of Hammurabi, written around 1700 BCE. However, growing wealth through conquest and corruption has been much more prevalent in the ancient world, thus making the art of investment much less relevant for many millennia. The concept of investing did not truly exist until stock markets of Medieval, Renaissance, and Enlightenment-era Europe brought it to the forefront of civilization in an organized and standardized way. Thus, when we talk about investing, we normally mean the establishment of a modern investment structure of stock trading, securities trading, and banking.
The merchants of Venice were trading government securities as early as the 13th century. Stock markets started in 1328 in Florence, and soon after expanded to nearby Italian cities of Pisa, Verona, and Genoa. Outside Italy, evidence of stock markets and stock market-like structures can be seen in German towns where local mine securities were sold at large fairs, and in French cities where municipal obligations were sold. Bruges, Flanders, Ghent, Rotterdam, and Antwerp in the Netherlands all hosted their own “stock” market systems in the 1400s and 1500s. All of these early “stock markets” had one thing missing: stocks. Although the infrastructure and institutions resembled today’s stock markets, nobody was actually trading shares of companies. Instead, the markets dealt with the affairs of government, businesses, and individual debt.
The real history of modern-day stocks began in 1602 in Amsterdam, when the Amsterdam Stock Exchange was established by the Dutch East India Company, Verenigde Oostindische Compagnie, (VOC), the world’s first multinational corporation and the first company to use a limited liability formula. The States General of the Netherlands granted the VOC a 21-year monopolistic charter over all Dutch trade in Asia and quasi-governmental powers of complete authority over trade defenses, war armaments, and political endeavors in Asia. The company was made up of merchants competing for trade in Asia, and to raise money, they sold shares of stock in the organization and paid dividends on them.
There was one simple reason why the East India Company became the first publicly traded company: demand for risk diversification. When the East Indies were first discovered to be a haven of riches and trade opportunities, explorers sailed there in large numbers, but only a few of these voyages ever returned home. The voyage to the precious resources in the West Indies was risky; ships were lost to pirates and disease, and fortunes were squandered. Stock issuance made possible the spreading of risk and dividends across a pool of investors, where risk was dispersed throughout the pool and each investor only suffered for a fraction of the total expense of the voyage. The Amsterdam Stock Exchange connected potential investors with investment opportunities while simultaneously allowing businessmen to connect with willing investors. The market offered volume and liquidity, publicized value, broadcast availability, and lowered transaction costs. In short, it made investing easier and more standardized.
After 21 years, neither the VOC nor its shareholders saw a slowing down of Asian trade, so the States General of the Netherlands granted the corporation a second charter in the West Indies. This new charter gave the VOC additional years to stay in business but, in contrast to the first charter, outlined no plans for immediate liquidation, meaning that the money invested remained invested, and dividends were paid to investors to incentivize shareholding. Investors took to the secondary market of the newly constructed Amsterdam Stock Exchange to sell their shares to third parties. These "fixed" capital stock transactions amassed huge turnover rates, and made the stock exchange vastly more important. Thus, the modern securities market arose from this system of stock exchange.
Soon after the successful experiment of the Amsterdam Stock Exchange, other stock markets began to appear throughout Europe. The excitement over these new companies made many investors foolhardy. The First and Second Industrial Revolutions were responsible for introducing investing and banking to an enormous portion of the population. Instead of spending everything they owned on things like food and shelter, people had extra money they could save for the future. They bought shares in any company that came onto the market, and few bothered to investigate the companies in which they were investing. This led to a series of spectacular bubbles, a pattern that is very much alive today.
Most major stock markets have experienced crashes at some point in history. Stock market crashes are by nature preceded by speculative economic bubbles and occur when speculations are stretched far beyond the actual value of a stock. In England, such a financial scandal, known as the South Sea Bubble, took place in 1720. The South Sea Company had been set up in 1710 to trade with Spanish South America. The proposed size of company profits was exaggerated, and the value of its stocks rose very high. These high stock prices encouraged the formation of other companies, many of which promoted farfetched schemes. In September 1720, South Sea stockholders lost faith in the company and began to sell their shares. Stockholders of other companies began to do the same, and the market crashed. These companies became known as "bubble companies" because their stock was often as empty and worthless as a bubble and the companies collapsed like burst bubbles.
Even though the fall of “bubble companies” made investors wary, investing as a way of growing wealth had become an established idea. The French stock market, the Paris Bourse, was set up in 1724, and the English stock market was established in 1773. In the 1800's, the rapid industrial growth that accompanied the Industrial Revolution helped stimulate stock markets everywhere. By investing in new companies or inventions, some people made and lost huge fortunes.
The Industrial Revolution was creating a new, increasingly affluent, middle class. While earlier business ventures had relied on a small number of banks, businessmen, and wealthy aristocrats for investment, a prospective railway company could interest a large, literate section of the population with savings to invest. New media such as newspapers and the emergence of the modern stock market made it easy for companies to promote themselves and provide the means for the general public to invest.
In 1825, the government had repealed the Bubble Act, brought in after the near-disastrous South Sea Bubble of 1720, that put close limits on the formation of new business ventures. With these limits removed, anyone could again invest money in a new company and railways were heavily promoted as a foolproof venture. Predictably, this did not end well.
Railway mania was the next instance of speculative frenzy to rock the United Kingdom in the 1840s. It followed a common pattern. As the price of railway shares increased, more and more money was poured in by speculators until the inevitable collapse. The UK was in the grips of a frenzy that saw investors tripping over each other to pile into railway shares, bewitched by promises of a revolutionary mode of transport, a huge untapped market, and spectacular profit growth. Private firms hatched grandiose investment plans, submitted hundreds of bills to Parliament for new railway lines, and saw their share prices roughly double in the space of a few years.
The Government was obliging; in 1845, it authorized around 3,000 miles of track, roughly as much as the previous fifteen years combined. At its peak, railway investment surged to 7% of GDP, representing half of total investment in the economy at the time. It reached its zenith in 1846, when no fewer than 272 Acts of Parliament were passed, setting up new railway companies, with the proposed routes totaling 9,500 miles (15,300 km) of new railway.
As with other bubbles, the Railway Mania became a self-promoting cycle based purely on over-optimistic speculation. As the dozens of companies formed began to operate and their unviability became clear, investors began to realize that railways were not all as lucrative and as easy to build as they had been led to believe. On top of this, in late 1845, the Bank of England raised interest rates, and as banks began to re-invest in bonds, the money began to flow out of railways, undercutting the boom. As the share prices began to fall, investment stopped virtually overnight, leaving numerous companies without funding and numerous investors with no prospect of any return on their investment. The larger railway companies such as the Great Western Railway and the nascent Midland began to buy up strategic failed lines to expand their network. These lines could be purchased at a fraction of their real value as given a choice between a below-value offer for their shares or the total loss of their investment, shareholders naturally chose the former. Many middle class families on modest incomes had sunk their entire savings into new companies during the mania, and they lost everything when the speculation collapsed.
After World War I an increasing numbers of small investors began to invest heavily in the stock market. There was a huge rise in speculative stock trading during the 1920's, and many people made fortunes. However, the Roaring Twenties came to an abrupt end in October 1929, when stock markets crashed and fortunes were wiped out overnight. The crash was followed by the Great Depression of the 1930's, a period of severe economic crisis throughout much of the world. After the end of World War II, small investors had again begun in stocks, and stock markets had been relatively stable for a time. A sharp fall in prices in 1987 led to another stock market crash. Initially, this frightened many people away from stock investments. But within a few months the market recovered and investor confidence returned.
The history of stock markets has been punctuated by periodic cycles of irrational exuberance followed by sharp and painful corrections that destroyed lives and wiped out wealth across a wide swath of investing public. Today, only 23% of those aged 18 to 37 say that the stock market is the best place to put money they won’t need for ten years or more, and there’s a good reason so many millennials are hesitant to put their savings into the stock market. Many have seen investments collapse twice within a period of a few short years; during the dot com crash of the early 2000′s and the 2008 crisis.
Most modern financial advisers and money managers are comfortable with traditional investment vehicles, such as stocks, bonds, and real estate. However, as we just saw, traditional investments are by no means a safe haven, and an increasing number of savvy individuals are instead exploring collectibles such as art, stamps, wine, books, classic cars, and the like as an alternative avenue for profitable investing, diversification, and wealth building.