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4 Lessons for Investors From the First World War

European alliances, 1914. Wikimedia Commons. 

On June 28, 1914, Archduke Franz Ferdinand was assassinated by a Bosnian Serb in the city of Sarajevo. The First World War followed thirty-seven days later, resulting in the deaths of 20 million soldiers and civilians. It may not be possible to overstate the impact of this devastating event on world history. 

In The Sleepwalkers: How Europe Went to War in 1914, Christopher Clark shows how European monarchs, politicians, soldiers, and diplomats "walked toward danger in watchful, calculated steps." This tragic story provides numerous insights for those of us who hope to learn from one of the greatest catastrophes of modern times. As we commemorate the 100th anniversary of the outbreak of the war, I thought it might be useful to explore four possible lessons for investors.

1. Avoid huge bets where the probabilities of failure are unknown.
After the assassination of Franz Ferdinand, Austria-Hungary's leaders issued a harsh ultimatum to Serbia, which had to either accept it or face war. Noting that neither side intended to back down, a French diplomat wrote,

On both sides they imagined 'bluffing' would suffice to achieve success. None of the players thought that it would be necessary to go all the way. The tragic poker game had begun.

Clark shows how Austria-Hungary was intent on taking a "temperamental, intuitive leap" in order to protect its future as a great power. Its leaders knew this policy risked a wider European war, yet they went ahead anyway, even though the outcome of such a war was unknown. As we now know, the war brought about the utter collapse of Austria-Hungary, as well as the demise of both the German and Russian empires.

We witnessed similarly reckless behavior during the recent financial crisis. Major financial firms like Lehman Brothers and AIG risked everything by taking on huge exposures in mortgage-related securities. As the Financial Crisis Inquiry Commission wrote, "Like Icarus, they never feared flying ever closer to the sun."

Of course, ordinary Americans also gambled heavily prior to the crisis by taking on more debt than they could possibly handle. As a general rule, individual investors and institutions should avoid making decisions where the probability of a disastrous outcome is real, but unknown. Violating that rule was one of the biggest mistakes made by the decision-makers in the run-up to the First World War in July 1914.

2. Systemic risk is hard to assess and difficult to manage.
Clark makes a persuasive case that war was not inevitable in the summer of 1914. The international diplomatic system had faced similar crises in the past, and it was reasonable to assume that the situation would eventually be resolved peacefully.

In July 1914, the international system ended up failing completely, however, and a horrific war ensued. War actually caught global financial markets by surprise. In the days after Austria's ultimatum, panic raged throughout the international financial system. By the end of the first week of August 1914, almost all of the world's securities exchanges were closed. The London Stock Exchange, which had never closed before, remained shuttered until January 1915. The New York Stock Exchange was closed from Aug. 1 until December 1914.

It's not easy for individual investors to anticipate the collapse of a financial system. Almost overnight, our portfolios can be decimated and our property values can plunge dramatically. The First World War -- like Sept. 11 or the financial crisis of 2008 -- shows us that "black swan" events are very real and hard to predict. Diversifying across asset classes and having a long-term outlook are two possible approaches to systemic risk. In general, investors must accept the fact that catastrophic events can happen at any time and can wreak havoc on even the most well-planned portfolio.

3. Seemingly rational leaders can make irrational decisions.
Clark provides an odd quote from Winston Churchill that illustrates the madness surrounding the decision to go to war. Just days before Britain's entry into the conflict, First Sea Lord Churchill wrote to his wife, "Everything tends toward catastrophe & collapse. I am interested, geared-up and happy."

The decision-makers in 1914 appeared to be responsible, prudent statesmen, but many of them were unable to see the situation clearly. They often perceived their own nation's security in purely defensive terms, while viewing their rivals as aggressors. This allowed the German military leadership, for example, to think of a preventive war against Russia as a perfectly rational strategy to contain their fast-growing rival. And this led Britain to eventually enter the war on the side of France and Russia, despite not having a clearly defined interest in the Balkans.

This type of "irrational" decision-making by leaders is always a huge risk for investors. The case of GM is a good example. The inability of GM's leadership to adequately deal with the faulty ignition switch problem led to devastating consequences. A recent internal investigation concluded that, "GM personnel's inability to address the ignition switch problem for over 11 years is a history of failures." In the political realm, recent showdowns over the debt limit show how leaders on both sides of the aisle were willing to risk another financial crisis in order to gain short-term political advantage.

4. A catastrophe can have long-term, incalculable effects.
After the decision to go to war with Germany, Britain's Foreign Secretary Sir Edward Grey famously remarked, "The lamps are going out all over Europe. We shall not see them lit again in our lifetime."

Grey's words were prescient. Four years later after the deaths of 20 million people and the collapse of three empires, the world remained a very dangerous place. Eventually, the rise of Stalin in post-tsarist Russia and Hitler in post-imperial Germany resulted in another disastrous catastrophe just over 20 years later. For over three decades, Europe was torn apart by war, revolution, and economic dislocation. A young household in Europe in 1913 would have had a very grim future ahead of it, regardless of how diligent its members worked or saved.

Successful investors tend to be optimistic about the future, and such an attitude has richly rewarded Americans over the past 100 years. The First World War, however, reminds us of how precarious civilization actually is. In 1914, Germany was one of the most advanced societies in the world. Three decades later it was literally a smoking ruin. And just a century ago, Britain was the global financial leader with an empire upon which the sun never set -– the First World War would mark the beginning of Britain's relative economic decline.

We were extremely lucky recently that our financial crisis did not result in even greater economic and financial hardship. Even with the upturn in the stock market, however, there remains some serious challenges with long-term unemployment and stagnating wage growth. And just because the textbooks say that investors can earn 10% from equities, year in and year out, does not mean that's a certainty.

Catastrophic events are always possible, and even the wisest investors will struggle to withstand their worst effects. If the First World War teaches us anything, it's that each of us has a stake in holding our business and political leaders accountable for the quality of their decision-making.

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Read/Post Comments (20) | Recommend This Article (45)

Comments from our Foolish Readers

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  • Report this Comment On July 14, 2014, at 10:41 PM, BillFromNY wrote:

    I'm surprised that there has not been more written about the First World War on its hundredth anniversary (just as I'm surprised that so few subscribers read and comment on these articles).

    I have twice read the late Barbara Tuchman's Pulitzer Prize winning book "The Guns of August," which follows the beginning of the war with the assassination in Serbia of the Austrian Archduke Ferdinand to the last desperate effort of the French and British armies to halt the advance of the German army short of Paris. Tuchman leaves the scene as the two sides begin digging the trenches that will result in four years of slaughterous stalemate in which (and these numbers can only be estimated) 700,000 British, 117,000 American, 1.3 million French, 1.2 million Austrian, 900,000 Italian, 1.7 million Russian and 1.7 million German soldiers were killed outright and millions more maimed for life.

    There was no reason for this war to occur. No country had invaded another or its colonies. All the powers were enjoying a relative period of peace and prosperity. That the death of one minor nobleman in the decaying Austrian empire should have escalated into a conflagration that took the lives of over 10 million soldiers (including those from the non-major powers), and defaced and disfigured millions and millions more was due to the pride and arrogance of the rulers of the European nations.

    World leaders today as well as leaders of financial institutions share the same traits and should not be trusted without strong cause.

    As Edward Gibbon famously put it, "History is little more than the register of the crimes, follies, and misfortunes of mankind."

    John Reeves has given four excellent cases in which human failings, including our own, can torpedo your best-planned investments.

    My own weaknesses are best reflected in an unsupported overconfidence that has caused a failure to diversify in either investment type or risk.

  • Report this Comment On July 15, 2014, at 9:11 AM, TMFBane wrote:


    Thanks for your comment! "The Guns of August" is an outstanding book that a lot of people might enjoy. And I completely agree that this was an unnecessary war, and think it's worthwhile trying to better understand what happened. 100 years ago really isn't all that long ago, in the overall scheme of things.


    John Reeves

  • Report this Comment On July 15, 2014, at 2:33 PM, BillFromNY wrote:

    Hello, John

    This was not one of my better comments. I got so carried away with my enthusiasm for Tuchman's book that I found that I had written about a page of comment without responding to your fine article and the analogies to be drawn between the origins of WW 1 and the financial decisions that we must make as investors.

    I felt that if I wrote any more the comment would get squelched for length so I just hastily concluded it and sent it off.

    I really hope that more people than it seems enjoy the free, high quality writing such as yours that appears in this space.

  • Report this Comment On July 15, 2014, at 3:33 PM, TMFBane wrote:


    I thought it was a great comment! Thanks again for sharing it.

    Fool on!

  • Report this Comment On July 15, 2014, at 5:21 PM, hbofbyu wrote:

    I am also surprised that more people aren't reading and commenting of Fool articles.

    Rational leaders will make irrational decisions. The unraveling of Iraq astounds me as most of the 10+ years in Afghanistan may end in vain.

    It is rare that a person (much less a leader) will not act of their own self interest - lucky for us much of the time a leader's interest is also our own. However I don't think we have had altruistic political leadership in this country for a long time. If you ask the politicians, they will tell you otherwise.

    People, even very smart people, can and will deceive themselves if they are rewarded for doing so. Maybe we all do it (deceive ourselves).

  • Report this Comment On July 15, 2014, at 6:01 PM, evandc1 wrote:

    Rationality is largely in the eye of the beholder. People act in their own self-interest, but not everybody shares the same the same priorities. Generally, people who act "against their self interest" and leaders who act "irrationally" are actually just pursuing different priorities than those favored by their critics.

  • Report this Comment On July 15, 2014, at 8:35 PM, dylan588 wrote:

    I should first point out that a lack of comments does not mean a lack of reading.

    I'll take a different view of the run-up to The Great War. Serbian nationalists thought Archduke Ferdinand would continue oppressing Serbia. In fact, Ferdinand was apparently quoted as calling Serbia something like "a bunch of rocky hills covered with goat droppings" and was entertaining giving Serbia at least a measure of independence. Stated another way, Serbian nationalists shot the wrong guy.

    War could have been avoided, but ego surrounding security agreements and the desire to gain colonies controlled by rival European countries overrode the cost of war. Then again, no one thought the war would last four years and kill millions. I believe the British were truly convinced things would be over in 6 to 12 months. In exchange for gaining German colonies and burnishing its international prestige, this was not a bad proposition.

    So, yes, rational people make decisions that seem irrational, but at the time, they are caught up in the heat of the moment, with a little greed thrown in, the decisions are more understandable in hindsight.

    Investors should do well not to get caught up in the heat of a hot stock or story without a reality check of some sort. Perhaps a question along the lines of "what if I'm wrong about this, what could happen?" would be in order.

  • Report this Comment On July 15, 2014, at 8:43 PM, Mpwwp wrote:

    A great article and very thoughtful comments.

    I agree with the article's points 2-4 completely.

    Regarding point 1 in the context of investing: I believe medium NOT huge bets are reasonable if one has conviction about the future of a technology/company despite the company's future being unknowable. I believe David Gardner's philosophy follows this and diminishes portfolio risk by attempting to make these home run shots across multiple companies/industries.

    I don't know much about WWI but it seems the politicians effectively invested everything on a single stock with small, possibly medium upside. That's the opposite of what many Fools do: small to medium bets on many stocks which each carry the potential for medium to huge upside. If we are less inclined to do this, there are certainly more conservative Foolish portfolios/strategies or a SPY etf, all of which I think are very reasonable.

    My point and, I think the most laudable characteristic of the Motley Fool, is that it is a platform to help seek out and make small to medium bets on companies where the probability of failure is unknown but the potential upside is enormous.

    Thanks for a great article.


  • Report this Comment On July 15, 2014, at 10:23 PM, TMFRhino wrote:

    Hey John,

    Very nice article!

    If you had to pick one, would you recommend "Sleepwalkers" or "Guns of August"?

    Naturally, would like to read both... But... One thing at a time :).


  • Report this Comment On July 16, 2014, at 2:16 AM, BillFromNY wrote:

    What makes the beginning of this war so unique is that such a world wide massacre of millions was set off by an assassination in the distant Balkans hardly noticed by Western European nations soon to be shedding so much blood over what was begun there.

    It is rather like a full blown WW III conflagration resulting from a South Korean submarine torpedoing and sinking a North Korean destroyer. North Korea rattles its nuclear weapons against the South and the US must come come to the aid of South Korea and China stands behind North Korea, etc.

    In fact, we did have a similar situation here. I never believed it until I saw some dramatic recreations, but we came within the possibility of a nuclear exchange over the Cuban Missile Crisis. Why? Because of the same reluctance to back down or fail to honor a commitment to an ally that we saw one hundred years ago. General Curtis LeMay belonged in an asylum, not in the West Wing.

    How ironic that it was that country hick Khrushchev who blinked first and backed away from the nuclear scenario at the cost of having to watch with humiliation the Russian ships turn for home. Surprisingly, he lasted two more years in his job.

  • Report this Comment On July 16, 2014, at 9:09 AM, TMFBane wrote:


    “The Guns of August” is an excellent book for the ordinary reader. The author is an outstanding writer and storyteller. It’d be a great read for summer vacation.

    “The Sleepwalkers” is more academic, and is laser-focused on the decision-making that led to the war. One thing I appreciated is that he’s an expert on all of the recent scholarship on this topic, so you’re also getting a thoughtful synthesis of all the various viewpoints. I can’t recommend it enough – though it is a somewhat challenging book. Forced to choose between the two, I’d recommend “The Sleepwalkers.”

    I’ll suggest one more. “The Great War and Modern Memory” by Paul Fussell is one of the best books on World War I that I’ve ever read. It’s a really quirky book about the Western front, loaded with odd facts and insights. I think everyone would enjoy this one -- it's amazing.

  • Report this Comment On July 16, 2014, at 9:15 AM, TMFBane wrote:


    That’s a great point about the Cuban Missile Crisis. It’s scary to think how close we came to nuclear disaster there. It does feel like there was a similar dynamic to the July crisis of 1914 – maybe one big difference is that it was a less complex system (bilateral as opposed to multilateral). Clark notes that the complexity of multilateral negotiations was a big factor in the 1914 systemic collapse.

  • Report this Comment On July 16, 2014, at 11:34 AM, Zinj wrote:

    Interesting that "ethnic minorities" are labelled in Austria-Hungary, an Empire in which there was no "majority" group (note that Germans were left out on the map).

    Yet, the same is not done for Russia - itself a polyglot empire filled with subjugated peoples, some of whom gained independent states after the war, an outcome not dissimilar to A-H's breakup.

  • Report this Comment On July 16, 2014, at 6:19 PM, duuude1 wrote:

    I agree with BillfromNY and Reeves that Guns of August was a phenomenal book!

    John, great article and although I agree with you in principle about war ("devastating...tragic...catastrophe...") - I think we need to be careful when we judge ("irrational decisions...unnecessary war...") huge, unthinkable events 100 years after the fact. We see WWI through the lens of what we know today, and what we've learned in the century since.

    If I recall, the nation states of Europe at the turn of the century were relatively young and inexperienced, having not so long ago emerged from monarchies and hundreds of years of empire-building warfare - but that these states emerged through the flames of revolution. The incredibly rapid pace of technological (war-fighting) evolution gave European leaders a view of the military possibilities through the carnage of the Civil War here in America. But no one had successfully managed the intersection of massive killing technology and international politics/diplomacy.

    The unknowns associated with rapidly emerging technologies and politics/society are where our biggest mistakes can occur - we're about to see how we handle things like the internet and net neutrality and privacy and corporate power...

    Although I am no fan of Rumsfeld, his now-famous quote about unknown unknowns is very very relevant - both in war and in investing.


  • Report this Comment On July 16, 2014, at 7:46 PM, TMFBane wrote:


    Great points! I completely agree about he significance of "unknown unknowns."

    I do believe there was irrationality involved in the decision-making, however. Russia is a good example. It had experienced modern war as recently as 1904-1905, when it suffered a disastrous defeat by Japan. By 1914, the tsarist regime had made some reforms, though its finances were shaky and its popular support was questionable. Its most talented Minister -- Pyotr Stolypin -- had been assassinated in 1911 by revolutionaries. In my opinion, a rational assessment of Russia's situation in 1914 would have resulted in the leadership avoiding war at all costs. Even Tsar Nicholas II hesitated in late July saying, "I will not be responsible for a monstrous slaughter." On some level, he clearly knew what was about to happen.

    But he went forward anyway. His ministers convinced him that nationalism plus the possibility of obtaining the Turkish Straits might shore up the regime. Alas, that delusion didn't work out in the end.

    Anyway, that's just one example. I do concede that the word "irrational" can mean different things to different people. One way or another, I think the tsarist government made a poor decision, given what they knew at the time.



  • Report this Comment On July 17, 2014, at 5:51 AM, Pixma25 wrote:

    regarding the cuban missile crisis. I'd like to point out that war was averted because Kennedy secretly agreed to remove nukes from alongside the Soviet Union in the NATO ally of Turkey.

  • Report this Comment On July 17, 2014, at 10:58 AM, mdk0611 wrote:

    Another difference with respect to the Cuban missile crisis was that the catastrophic cost of conflict was obvious to both sides in a way it wasn't in August 1914.

    Another fan of Guns of August.

  • Report this Comment On July 17, 2014, at 11:10 PM, katyfcolorado wrote:

    Excellent article! Thanks for the timely and relevant connections between historical events and our own investing decisions.

  • Report this Comment On July 18, 2014, at 10:56 AM, BillFromNY wrote:

    Yes, the US agreed to remove the missiles from Turkey, which brings up several interesting points.

    How does the US get away with being so righteous about Soviet missiles in Cuba when the US had analogous missiles so close to the Soviet Union?

    The agreement to remove the Turkey missiles was not made public, doing nothing to counter the appearance that the Soviets were backing down due to a mere promise by the US not to invade Cuba. The Soviet Union perhaps more than any other nation should have understood the worthlessness of such a promise based on its experience with the German-Soviet Nonaggression Pact of 1939.

    When I look back at World War I (The Great War), it comes down to one major point: how could the generals of both sides for four years continued launching "offensives" by having the infantry rise out of its trenches and attack entrenched machine guns with artillery shells falling all around them? After the first two years or so, didn't they learn anything?

    My take from this is never to say of a politician or a military leader that that person could not possibly be stupid enough to take a certain action.

    Yes, they could be that stupid.

  • Report this Comment On August 09, 2014, at 12:37 AM, ibme2now4u wrote:

    First let me clue you the 'Web" isn't "going dark", you're full of poo-poo, so take your web site and "shove it"....................................

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