The GameStop stock surge has taken Wall Street by storm. What Wall Street once derided as ‘dumb money’ (individual investors, or ‘Main Street’) might not be so dumb as ‘smart money’ was taken to the woodshed. Score one for the little guy as a rag-tag group of investors took down at least one hedge fund with GameStop, AMC and other heavy short-sell stocks.
However, there’s a big difference between investing and speculating. It can be fun to take a flyer now and then. Just be careful with your money earmarked for precious goals such as retirement and your kid’s education. This article summarizes what’s going on with the retail investors’ revolt and investor mistakes to avoid.
Modern Day “Trading Places”
Trading Places, a 1983 movie, is about how a snobbish investor, Louis Winthorpe III, and a street con artist, Billy Ray Valentine, get rich while bankrupting the Duke Brothers on the commodities trading floor. Today we have a remake with the roles of Louis and Valentine played by Reddit’s popular forum r/wallstreetbets (WSB), and the Duke Brothers played by hedge funds. The retail investor community at WSB bought stocks that were targeted by short-sellers. GameStop was one of the most prominent stocks with a short interest of 260% (over twice as many shares shorted than those on the market in the first place). Several brokerage firms, including Robinhood, shut down buy orders for GameStop, AMC and others in an effort to limit their own potential losses. That sparked outrage in the retail investment community and got the attention of regulators.
It looks like the little guys beat the big guys. Hedge fund losses on GameStop in January were estimated at $19 billion according to S3 Partners, a New York firm that tracks short positions. And there, new millionaires amongst small investors egged on by social media as GameStop shares soared 1,700%.
However, not all GameStop shareholders will be profitable, nor are they profit-motivated. Shares were most volatile last Thursday – highs of $460 or so, lows $132 or so, and closed around $200. Some traders may have bought at the high and sold at the low for a loss of almost 70%. What’s the value of GameStop once the bubble is gone – more like $20 or lower as the shorts believe. And the stock may be driven by pure emotion from people who were hurt by the 2008 financial crisis, who want to “put it to the man,” and are willing to ride it to the bitter end.
So, here are some tips to consider.
Prudent saving and investing are boring and take hard work. There are no short cuts for the majority of us. And they call it the “Rule of 72” not the “Rule of Two.” It is a method for estimating an investment’s doubling time given a fixed annual rate of return (72 / interest rate = years to double).
Investors can be their own worst enemy. DALBAR Inc., a research firm, has published its annual “Quantitative Analysis of Investor Behavior” report since 1984. They compare the average equity fund investor to the index over the trailing 20 years. The most recent report showed the average investor lagged market indexes (the S&P 500 and a global index) by about 2 to 4% annually.
Strive to achieve investment returns, not investor returns, by avoiding these mistakes:
- Greed and panic
- Concentration – Diversification is the trade-off of never making a killing for the blessing of never getting killed
- Market timing – Difficulty in doing two things very well (buy and sell) and things tend to smooth and trend to the average over time
- Not having a long-term plan
Small investors have a new power. Hedge funds contemplating to short-sell stocks are likely to rethink that strategy in the face of angry mobs and price spikes. However, as a shortcut to building long-term wealth, be prepared for the risks. Instead, consider limiting your thrills by having stop losses, and dedicate the bulk of your serious money to a diversified portfolio of quality investments that is more capable of riding good times and bad. Secure your future wisely and seek sage advice.