Why a 'Fomo' strategy won't work with meme stocks
It's better to stick to low-cost index fund investing for long-term gains
A few weeks ago, the world went berserk due to a popular uprising. The little guy was fighting back against entrenched powers and even managed to temporarily stun and overwhelm the oligarchic forces that so often swamp their proletarian dreams.
Yes, I’m referring to the meteoric rise of US video game retailer GameStop and the battle between Reddit sub-group WallStreetBets and giant hedge funds with billions of dollars at their disposal.
If you were living under a rock the past few weeks, I’ll give a very quick summary, but there are plenty of great sources that break this down in far more detail than me because this article isn’t really about GameStop or Reddit.
A group of people on the internet noticed that big hedge funds were betting the price of GameStop would go down and a lot of them decided to buy the stock. Due to complicated stock market mechanisms, the price skyrocketed. A stock that started at $4 a share ended up peaking at $396.51 per share.
The investing world went haywire. Online stock trading platforms such as Robinhood stopped allowing people to buy or sell GameStop shares, government agencies got involved and the internet was on fire. A new term was added to the cultural lexicon: meme stock (which experience rapid price growth because they are hyped on the internet).
This was where I got involved. No matter how much I preach about the benefits of low-cost index fund investing and the benefits of this strategy for my finances, I’m still human. When I see people making money very quickly, I get the fear of missing out. This is despite knowing that individual stock picking is a very risky strategy unlikely to work for many people.
One of my friends, who follows WallStreetBets, sent me a message saying the next shorted stock to focus on was AMC, an American movie theatre company. He was putting $20,000 into the stock at market opening and told me to get in on the action.
I got excited but fortunately not to the tune of $20,000. Instead, I invested $1,000 as soon as the market opened and bought shares at $17.90 each. It was at this point that the stock price started dropping. By the end of the week, the stock was down to around $5 a share and most of my investment value had disappeared.
When I see people making money very quickly, I get the fear of missing out
Fortunately, the loss wasn’t financially crippling. It was, instead, a lesson in the danger of adopting a “Fomo” strategy and the power of the “reversion to the mean” phenomenon.
The main idea behind reversion to the mean phenomenon is that over a long timeline, the vast majority of investors in individual stocks will at best only get the same return as the overall market.
In 2008, Warren Buffett placed a $1 million bet with the most successful hedge fund managers that over a 10-year timeframe, they wouldn’t be able to beat the average market returns. He won.
This is why low-cost index fund investing is so powerful. You end up getting better returns and it’s a lot easier. You don’t have to pay attention to financial news, worry about timing the market or obsess when a stock price has hit top or bottom. You just buy low-cost index funds that cover a lot of the stock market and continue investing, no matter what. It’s simple and it works.
Don’t let “Fomo” or meme stocks get you overly excited. Instead, choose the simple, boring path when it comes to your investments. It will save you time and energy –not to mention keeping your stress levels down.
Schoolteacher Zach Holz (@HappiestTeach) documents his journey towards financial independence on his personal finance blog The Happiest Teacher
Published: March 5, 2021 08:00 AM