Posted By The Pitfalls of Fanatically Following the Stock Hype
By Steve Lowrie, CFA
Special to Financial Independence Hub
“There are recurring cycles, ups and downs, but the course of events is essentially the same, with small variations. It has been said that history repeats itself. This is perhaps not quite correct; it merely rhymes.”
Dr. Theodor Reik
It seems to me that the central tenet of the financial media (group-think central) is to glorify stocks or sectors that have experienced recent outsized returns. The hype of cult stocks extends and is amplified by social media channels and its various influencers. Ask any reputable financial economist about these past monumental gains and they will indicate that “past performance is not indicative of future returns.”
Despite the restrained advice of these financial experts, it’s easy to get swept up in the hype surrounding these popular stocks and investment trends. Some choose to surrender to FOMO (fear-of-missing-out) and follow these financial fads. for the chance of scoring a big financial win with a little excitement on the side. While these stocks may seemingly promise rapid growth, there are some obvious (and not-so-obvious) risks of chasing high-flying stocks.
It’s important to consider the other option: a more thoughtful, measured investment plan. Maybe not as thrilling, but certainly a better path to reaching your long-term financial goals.
In my experience, the greatest risk to someone’s financial well-being is not so much panicking and selling in a bear market (although that can be devastating), it is getting caught in up in a fad in an up market. Just look back at previous fads or bubbles like dot-com stocks (late 1990s-early 2000s), housing and mortgage crisis (mid-2000s), SPACs (2020-2021), and cannabis stocks (2018-2020), to name just a few. In all these cases, there are numerous examples of hyped stocks running up, but then going down 90% or worse. This is where we need to embrace the theory of history repeating itself to be alerted to the potential pitfalls of investing in cult stocks: they might bring the excitement but they typically underperform and create significant risk.
Let’s explore some examples of how some stocks can achieve a cult-like following and a take realistic look at how they could play out for some real-life investors.
Individual Stock with a Cult-Like Following
Looking back helps us see what is most likely to happen in the future. So, we’ll look at two individual stocks that ended up with a cult-like following.
By 2020, Nvidia was no longer just a stock: it had become a movement. There were legions of investors, bloggers, and social media influencers all singing its praises. You could barely scroll through an investment forum without seeing someone post about Nvidia being the future, with charts projecting its exponential growth.
Similarly, Peloton had developed a near-cult following. The company’s sleek bikes weren’t just fitness equipment: they were a lifestyle. And its stock wasn’t just an investment: it was a symbol of the new, post-pandemic world. As Peloton soared, so did the confidence of its investors, who believed they had found a company that was reshaping fitness forever.
But there are two major problems that plague hyped stocks:
- People start to believe that the company can do no wrong and that its growth is limitless. And they make investment decisions based on that ill-conceived confidence.
- Investors are real people with real emotions and real egos. Cult-like stocks can cloud judgment, leading to irrational decisions based on emotional narratives rather than rational analysis.
And that’s where the danger lies.
The Reality of Compounding and the Impossibility of Endless Growth
For those watching Nvidia and Peloton stocks with bated breath, it seemed like the stock would climb higher, feeding the belief that it would never stop. But here’s the thing about high growth rates: eventually, they hit a wall.
Let’s break it down: Nvidia’s market value today is about $3.4 trillion, and the entire U.S. stock market is worth around $55.2 trillion. If Nvidia kept growing at 32% annually while the market grew at a typical 10%, in less than 20 years Nvidia would make up 100% of the entire stock market.
That’s impossible.
No company can make up 100% of a market that includes every company. At some point, the math just doesn’t work. Yet in the heat of the moment, many investors don’t think about that. They were so caught up in Nvidia’s incredible growth that they assumed it could just keep going.
But in the stock market, what goes up can come crashing down.
When the pandemic waned and people started going back to gyms, Peloton’s sales fell. Its stock price, which had soared by 500%, tumbled by more than 80%.
What investors didn’t realize is that outsized returns like 32% annually for Nvidia or 500% for Peloton don’t last forever. No stock can keep compounding at such high rates indefinitely. In fact, the higher the growth, the harder it is to sustain.
For every Nvidia that defies expectations for a while, there are countless Pelotons: stocks that rise quickly but fall just as fast. The excitement and fervor around these “cult stocks” can make it easy to ignore the reality: high growth eventually stops, and the bigger the growth, the harder the fall when it comes.
The Emotional Trap of Cult Stocks
When a stock becomes a movement, like Nvidia or Peloton did, investors often fall into an emotional trap. They start to believe that their stock can only go up, and they cling to it even when the data suggests otherwise. This is where the cult-like following can become dangerous. It’s not just about numbers anymore: it’s about identity, belonging, and belief.
A hyped-up investor can come to believe in their stock so strongly that they willfully disregard data that suggests the stock’s looming downfall. And when the stock crashes, it can rock them to their emotional core.
In addition to emotional investing, ego can play a major role in financial decisions. Think about the talk around the office water cooler; it usually involves some light bragging about unimaginable investment gains on the hottest stock. But do you ever hear about the inevitable fall of those cult investments?
People are human. They want their peers to respect them and think they are brilliant. And it feels good to talk about their successes and impress their coworkers. Which makes it even less likely that they will cut their losses and have to admit an investment downfall. In fact, when there is a loss, it can often make the cult investor even more determined to regain their big wins.
Consider how behavioural finance theories impact our investment decisions; it’s such an important concept that we’ve written several blogs on the topic:
- Play It Again, Steve – Timeless Financial Tips #4: How to Manage Your Financial Behavioural Biases
- Behavioural Finance Focus: Cost Savings Tips to Attain Financial Freedom
- Q&A: What is behavioural finance: And what’s it to me?
Instead of focusing on individual stocks, smart investors build diversified portfolios, which mitigate the emotional highs and lows of stock performance and allow for participation in broader market growth.
The Tale of Three Investors
Let’s take a realistic look at how this could have played out for some real-life investors…
Meet Barry, Robin, and Maurice. They were coworkers at a mid-sized corporation. They had similar lifestyles and investing background/goals:
- Age 45 – 50
- Married
- 2-3 kids, aged 13 – 23
- Senior manager or director at their company
- Accumulators: they had made significant progress towards their financial goals but were considering their options to kick it into a higher gear
They all started their investing journey like many others, hoping to grow their wealth. But their experiences offer a cautionary tale about the dangers of chasing hot stocks, the emotional allure of cult-like followings, and the unrealistic expectations of outsized returns.
Meet Barry:
Years ago, the current poster child of the Artificial Intelligence (AI) revolution, Nvidia was a company known mostly for its graphics cards. It wasn’t the $3.4 trillion giant it is today, but Barry believed in its future. He saw the rise of gaming and over time, artificial intelligence. Based on the internet rumblings, he thought Nvidia was perfectly positioned.
Up until that point, he had been working with a financial advisor who provided advice that had served him well over the years in building and executing a successful path for his financial future. However, he was very excited to get in on the Nvidia wave, so he decided to transition to a more DIY investing mentality and bought in.
“No risk, no reward,” he thought.
As the years went on, Nvidia didn’t just grow: it exploded. The stock skyrocketed 32% annually, a level of growth most investors only dream about. By the time AI started making headlines, Nvidia’s rise seemed unstoppable. Barry’s once-small position had ballooned into a major part of his portfolio, making him feel like he had struck gold.
Barry felt like a genius for holding Nvidia as it soared, but he also felt the pressure of managing such a large position. The fear of missing out on future gains kept him from selling, even though he knew in his heart that no stock could grow at 32% forever. He didn’t want to stop riding the wave.
It seemed as though Barry should be over the moon. But the reality was that as much as he was excited by the progress his Nvidia stock had made, he was stressed out. He spent most of his time watching the markets, running different scenarios, reading financial research reports and articles, and crunching numbers. He was constantly debating the merits of selling vs. holding.
Taking the money and running is easier said than done. He wanted to continue to ride the wave. But when would the wave crash? His FOMO encouraged him to continue to hold instead of realizing his fortunate gains.
The reality is that Barry’s lucky stock choice of Nvidia was like finding a golden needle in a haystack. He may have fluked into a windfall but was sweating nonetheless and would likely make the wrong emotional decisions which would reduce his gains. He took on a ton of risk and lucked into a potential huge reward. But how much reward would he actually realize and was it worth the risk and stress? Very likely not.
Meet Robin:
Then there was Robin, who didn’t find Nvidia early but thought he had his own golden investment opportunity: Peloton. Like Barry, he felt it was time to risk some of his hard-earned investment portfolio to make a run at some big gains. Although his trusted financial advisor advised a steady approach to growth, Robin wanted to jump on the Peloton bandwagon.
So, during the pandemic, he invested heavily in Peloton. Everyone was stuck at home, and Peloton’s sales were booming. It seemed like the perfect stock to ride the pandemic wave. And at first, he was right. Peloton surged 500%, and Robin was on cloud nine, convinced he had found the next big thing. Robin decided to hold the hyped stock, hoping for even bigger success. Unfortunately for Robin, Peloton was not going to continue to perform like Nvidia.
When the Peloton stock crashed, Robin’s once-promising investment was now a huge loss, and he was left wondering how he had misread things so badly. Robin took a big swing and missed. He felt terrible and now needed to start from scratch to rebuild what his impulsive Peloton decision had cost him and his family.
Robin’s experience is actually a much more common scenario than Barry’s as there are far more hyped stocks that fizzle out and result in big losses than magic bullets. There are countless cult stock investors with regrets.
Meet Maurice:
Maurice listened politely to all the excited discussion at the water cooler from Barry and Robin about Nvidia and Peloton. As much as the “no risk, no reward” mentality was appealing, Maurice took a more restrained approach. He trusted the evidence: both his own investment experience and historic data on these “get rich quick” cult stocks.
His independent financial advisor recommended avoiding the hype and staying the course. So, Maurice listened to his dependable expert and stuck with his financial plan that had been working well all along: lower-risk investments, diverse portfolio, with a long-term vision.
In the end, Maurice realized solid gains in the subsequent year. He was relaxed and happy to continue to build his investments, steadily and without stress. It might not be as exciting as Barry and Robin’s journeys, but it also didn’t have him ripping his hair out; it mitigated his risk while reliably achieving his financial goals.
The Lesson: Don’t get caught in the Hype
Barry and Robin’s stories highlight an important lesson for all investors: don’t get caught in the hype of hot stocks or investment fads with cult-like followings. The allure of rapid growth can be seductive, but it’s rarely sustainable. When a stock has soared to incredible heights, it’s easy to believe that it will keep going, but history shows us that growth always slows: and often reverses dramatically.
For every Barry, there are 100 Robins who lose their shirts. The probability of hitting on the magic stock is so low, it’s like a buying a lottery ticket. It’s even worse because the stakes are so high; the risk of losing the initial investment plus the opportunity cost of missing out on a more stable investment.
Even if you pick correctly, it’s highly unlikely that you are going to ride the wave the entire time to realize the gain reported and sell at the perfect time to capture it. Most investors would likely sell far earlier or sell way too late.
For investors like Barry, the key isn’t to try and keep riding Nvidia’s wave, it is about having a proper risk management and diversification plan in the first place. For Robin, the lesson is even starker: no matter how great a story seems, fast-gaining stocks like Peloton can come crashing down as quickly as they rose.
The Real Takeaway: Avoid Cult Stocks, Embrace Realistic Returns
Barry’s Nvidia story and Robin’s Peloton experience both serve as warnings. Hot stocks with cult-like followings can be dangerous. The expectation of endless, outsized growth is a fantasy. Compounding at 32% or seeing 500% gains is exciting, but it’s not sustainable: and believing that will lead to disappointment and possibly financial devastation.
Instead of chasing the next Nvidia or Peloton, smart investors focus on building diversified portfolios. Diversification is the antidote to the emotional traps of stock picking. It allows you to participate in the overall growth of the market while avoiding the emotional rollercoaster of watching a single stock dominate your portfolio: you’ve spread your bets across hundreds or even thousands of stocks, reducing your risk.
The key takeaway is to avoid the enticing pull of cult stocks and unrealistic expectations of perpetual growth. Successful investors stick to a long-term strategy of diversification and realistic returns, allowing the market to work for them and steering clear of hype-driven decisions.
Let patience be your guiding principle—and leave the hype behind.
Steve Lowrie holds the CFA designation and has 25 years of experience dealing with individual investors. Before creating Lowrie Financial in 2009, he worked at various Bay Street brokerage firms both as an advisor and in management. “I help investors ignore the Wall and Bay Street hype and hysteria, and focus on what’s best for themselves.” This blog first appeared on Steve’s blog on Dec. 11, 2024 and is republished here with permission.
Disclaimer: Steve Lowrie is a Portfolio Manager with Aligned Capital Partners Inc. (“ACPI”). The opinions expressed are those of the author and not necessarily those of ACPI. This material is provided for general information, and the opinions expressed and information provided herein are subject to change without notice. Every effort has been made to compile this material from reliable sources; however, no warranty can be made as to its accuracy or completeness. Before acting on the information presented, please seek professional financial advice based on your personal circumstances. ACPI is a full-service investment dealer and a member of the Canadian Investor Protection Fund (“CIPF”) and the Canadian Investment Regulatory Organization (“CIRO”). Investment services are provided through ACPI or Lowrie Investments, an approved trade name of ACPI. Only investment-related products and services are offered through ACPI/Lowrie Investments and are covered by the CIPF. Financial planning and insurance services are provided through Lowrie Financial Inc. Lowrie Financial Inc. is an independent company separate and distinct from ACPI/Lowrie Investments.
