The Lesson We Must Learn From the Death of the Meme-Stock Movement
The revolution will not be monetized.
Bloomberg recently reported that day traders in the “meme-stock” craze of 2021 have lost all of their gains from the ludicrous run-up in value of GameStop and other meme stocks.
This story deserves more attention than anything else that is happening in the financial markets right now — but it will barely be remarked upon.
Headlines about making easy money jumping on the bandwagon will always drive more traffic than telling the truth — which is that investing your money based on what’s popular almost always ends badly.
Like with any bubble, for every trader who made a fortune during the early days of the meme stock mania, there are dozens of other people who lost their money because they invested at the top.
A bubble born of desperation
I recently wrote about why so many Millennials invest heavily in crypto despite the fact that many of them do not fully understand what they are buying.
Young investors pile into crypto for the same reason they piled into meme-stocks; because they are financially desperate.
Consider a generation graduating with crippling student loans during the financial crisis, spending years getting beat down by a weak job market, and housing costs rising much, much faster than their incomes.
Millions of younger people believe that the traditional paths to wealth — going to college, buying a house, diversifying, and investing for the long run — are no longer viable options for them.
It does not matter if they are right or wrong. What matters is that they believe it. I’m reminded of my favorite quote from Inception.
An idea is like a virus, resilient, highly contagious. The smallest seed of an idea can grow. It can grow to define or destroy you.
If the idea that the old ways of building wealth are dead continues to grow, it leads to an unavoidable conclusion; we need to create new ways of creating wealth.
Enter the popularity of “new” strategies of wealth creation in the form of crypto and meme-stocks. These “strategies” not only promise a new path to creating wealth, but they also offer a community.
It’s good marketing but bad money management.
Investing in what’s popular is an easy way to lose money
There are tens of thousands of publically traded companies in the world, but the meme-stock traders focus on a tiny fraction of those stocks. Specifically, they invest in stocks that are generating lots of buzz online and in the media.
Limiting your investment opportunities to the select number of stocks that are driving the news is an easy way to lose money.
A 2021 research paper titled “Internet Search, Fund Flows, and Fund Performance” used Google search volume as a measure of investor attention to explore the connection between investment funds that were grabbing attention and the future performance of those investments.
If an investment fund saw a spike in Google searches, they wanted to know how much money poured into the funds after that spike in traffic and how the fund performed.
They found that retail investors were more likely to buy these funds generating online buzz. Unsurprisingly, these attention-driven investors had negative future returns.
It’s a pretty simple picture to paint.
- Search traffic for an investment fund is highly correlated with its past returns.
- Once a fund does really well, it gets investors’ attention.
- Investors pile into the fund, expecting the fund to continue to outperform.
- This is called “return chasing.”
- Predictably, these superstar funds tend to perform poorly after everyone has piled into them.
- The most recent investors who bought at the top lose the most money.
The perfect example of this is Cathie Wood’s ARK Innovation fund. An investment manager constantly in the headlines making bold — attention-grabbing statements.
In late 2021, Wood suggested that ARK “could deliver a 40% annual compound rate of return over the next five years.”
What happened next?
At the time I write this, ARK is down 75% from its all-time highs. Despite that ARK fund had $1.3 billion in positive inflows for 2022.
Translation: the fund is down 75%, but investors keep pouring money into it, throwing good money after bad.
The Internet Search, Fund Flows, and Fund Performance paper has a great quote to summarize their findings.
“Investors cannot generate superior fund-related future returns when they exclusively follow online buzz and associated suggestions.”
Don’t turn your investments into a job
Trading stocks is a lousy way to get rich.
Trying to pick and choose the right stocks at the right time based on what’s popular on Reddit it’s a huge waste of time, money, and emotional energy.
Here’s a simple, boring solution based on the best available evidence to build wealth.
Spend as little time as possible thinking about your investments and spend more time looking for ways to cut back your spending and increase your income, allowing you to have more money to invest.
Having more money to invest will help you build wealth. Spending time day-trading will not.
Focus on maximizing your income, keeping your living expenses low, and investing the difference in low-cost, highly diversified investments. Rinse and repeat for long enough, and you will begin to accumulate wealth.
It’s not a rocketship, but at least it’s real.
Become A Money Master
This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.