Tag Archives: speculation

Real Life Investment Strategies #6: Beware the Risk of the Cult Stock Roller Coaster

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The Pitfalls of Fanatically Following the Stock Hype

Graphic by Steve Lowrie: Canvas Custom Creation

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:

  1. 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.
  2. 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:

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 Continue Reading…

Retired Money: Is “Core & Explore” too dangerous for retirees and near-retirees?

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My latest MoneySense Retired Money column revisits the topic of Core & Explore. You can find the whole column by clicking on the highlighted headline here: Rethinking Core & Explore.

If the image on the left looks familiar, it’s because we used it last week to illustrate a republished blog on Explore by Michael J. Wiener, the blogger behind the popular Michael James on Money blog.

Go back to a couple of my Retired Money columns the last year and you’ll see I touch on the topic of speculation for retirees more than once, usually couched in the context of Core & Explore.

See for instance these pieces: Should Retirees Speculate? and How to Master Core & Explore.

“Core” is the prudent long-term strategy inherent in the MoneySense ETF All-Stars: low cost, diversified across geographies and asset class. Fully takes advantage of the “only free lunch:” that of broad diversification.

“Explore” on the other hand, is the polar opposite. The theory is that if you’ve taken care of 80 or 90% of your “Core” or Serious Money, you can go crazy with the other 10 or 20%, by “scratching the itch” of taking flyers on all those crazy things we’ve seen lately, like SPACs, cryptocurrencies etc., nicely surveyed by CFA Steve Lowrie in this recent blog: SPACS, NFTs and another Tech-inspired Silly Season.

Of course, as long as markets keep soaring, it’s hard not to love assets like Bitcoin or Ethereum, which may have tripled or quadrupled in a matter of months. Anyone who bought Tesla a year or two ago, or the ARK ETFs that were roughly 10% in Tesla and many comparable high flyers, was looking like an investing savant by the end of 2020, including Yours Truly. Continue Reading…

The dangers in the “Explore” part of a “Core and Explore” Portfolio

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By Michael J. Wiener

Special to the Financial Independence Hub

Many people advocate having a portfolio made up of mostly a core of low cost index funds along with a small “explore” part for taking concentrated risks on favourite investments.  This can work well enough if you’re realistic about it, but most investors cross the line to self-delusion.

Ben Carlson does a good job justifying the existence of explore-type investments in his article The Case for Having a Fun Portfolio.  After all, people are entitled to spend their money however they want.  Not every expenditure has to be part of a logical long-term plan.  We can buy a beer, or a motorcycle, or some favourite stock if we want.  So what if the long-term expectation is that the explore part of people’s portfolios will underperform indexes.

All the logic makes sense up to this point.  But just about every stock-picker I know can’t resist taking this a step further.  “Besides, the stock I picked is going to do great.”  In their hearts, they know their stock picks are going to outperform.  Past results don’t seem to deter them.  They wouldn’t bother with the explore part of their portfolios if they truly believed they would lose money over a lifetime of picking stocks.

All the evidence says that professional investors today set good relative prices so that individual investors who choose their own stocks are essentially making random picks.  The odds are against the small guy, but hope springs eternal.  I prefer to find hope in other pursuits.

Michael J. Wiener runs the web site Michael James on Money, where he looks for the right answers to personal finance and investing questions. He’s retired from work as a “math guy in high tech” and has been running his website since 2007.  He’s a former mutual fund investor, former stock picker, now index investor. This blog originally appeared on his site on April 26, 2021 and is republished on the Hub with his permission.  

A sampling of comments from the original post: Continue Reading…

Beware Experts bearing Forecasts

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By Noah Solomon

Special to the Financial Independence Hub

In 1985, Philip Tetlock, a Professor at the Wharton School of Business, set out to ascertain how accurate expert forecasters are in their predictions of future events.

Tetlock’s study covered many areas, including economics, politics, financial markets, climate, military strategy, etc. His analysis spanned nearly 20 years, during which he interviewed 284 experts and obtained roughly 82,000 forecasts.

Tetlock’s expansive research led him to conclude that:

  1. Expert forecasts were less accurate than random guesses.
  2. Aggregate (average) forecasts were superior to individual forecasts but were still inferior to random guesses.
  3. Experts who made the most media appearances were the least accurate.

In short, you would have been better off throwing darts while blindfolded than following the advice of experts.

But Investment Professionals Are the Exception – NOT!

Successful wealth management is predicated on both security selection and asset allocation. In order to achieve long-term results that are better than those that could be obtained by flipping a coin, investors must be able to:

  1. Select outperforming stocks/sectors, and/or
  2. Identify outperforming asset classes (whether stocks will outperform bonds, which countries will outperform, etc.).

Unfortunately, there is ample evidence that demonstrates hese two skills are in extremely short supply, leaving most clients holding the proverbial bag of underperformance.

Stock Picking: A Zero-Sum Game

Nobel Prize winning economist Eugene Fama is widely heralded as “the father of modern finance.” According to Fama:

“Active management in aggregate is a zero-sum game. Good active managers can win only at the expense of bad active managers. Any time an active manager makes money by overweighting a stock, he wins because other active managers react by underweighting a stock. The two sides always net out – before the costs of active management. After costs, active management is a negative-sum game by the amount of costs borne by investors.

After costs, only the top 3% of managers produce a return that indicates they have sufficient skill to just cover their costs, which means that going forward, even the top performers are expected to be only as good as a low-cost passive index fund. The other 97% can be expected to do worse. It is a matter of arithmetic that investors who go with active management must on average lose by the amount of fees and expenses incurred.”

Time: Active Management’s Nemesis

Both Standard & Poors’ Index vs. Active (SPIVA) scorecards and Vanguard’s Case for Indexing reports have repeatedly demonstrated that while some managers do outperform, it typically is not by much and not for long. The following table strongly suggests that the longer a portfolio of actively managed funds is held, the greater chance it has of underperforming one comprised of index funds.

What about Risk?

A common defense offered by active managers is that their superior risk management/lower volatility more than makes up for their inability to outperform their benchmarks. However, as the table below shows, this claim is not supported by the evidence. In comparison with their index fund counterparts, actively managed portfolios have on average performed just as poorly on a risk-adjusted basis as they have on a raw return basis.

To be clear, we do not believe that active funds cannot beat their benchmarks because the evidence shows that some can. There have been and always will be those that can add value. However, even the most astute investors cannot predict which funds will outperform and over what period, making the exercise of predicting winning managers somewhat of a fool’s errand. In other words, it is possible to outperform by selecting winning managers, it’s just not probable.

What about all those Smart People? Benjamin Graham spawned a Tribe of Cannibals

Benjamin Graham is the architect of modern security analysis, which uses fundamental data (income statement and balance sheet items) to determine the fair value of stock prices. Graham’s approach was way ahead of its time and remained largely undiscovered for several decades. This enabled him to achieve an annualized return of roughly 20% from 1936 to 1956, as compared to 12.2% for the overall market. Warren Buffett describes Graham’s The Intelligent Investor (1949) as “the best book about investing ever written.”

Today, there is no shortage of adherents to Graham’s approach. The current active management universe is both inundated with and driven by Graham-style security analysis. Stocks are constantly and continuously scrutinized by armies of security analysts, armed with reams of widely available fundamental data.

It’s hard enough to outperform in an area heavily populated by “smart money.” It’s even harder to outperform when you are trying to make money the same way as all those smart people! Graham’s approach has become a victim of its own success, whereby its followers are literally eating each other’s lunch to the point where most of them fail to add value. All the smart people are doing the same smart things, which causes their results to look not so smart. In the end, Adam Smith hath vanquished Benjamin Graham!

No Reprieve from Asset Allocation

What about asset allocation? Maybe investment professionals who cannot select outperforming stocks can add value by identifying when stocks will out/underperform bonds, which countries/regions will outperform, etc. As is the case with stock-picking, investment professionals have struggled with asset allocation. Continue Reading…

Gold still trusted over Bitcoin, but gap is closing

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A report by LendEDU finds Bitcoin is making a lot of headway with investors over Gold. 56% said Bitcoin is a better investment to maximize profits, versus just 33% for gold. However, they still see gold as a better store of value against inflation, with 50% answering gold  (including 67% over the age of 54), and 39% saying bitcoin.

On behalf of New Jersey-based LendEDU, research firm Pollfish surveyed 1,000 Americans on April 21st to see how they would deploy an initial US$50,000 to build a retirement nest egg, and found gold only had a slight edge: 45% versus 42% for bitcoin. However, if the goal of the $50,000 investment is strictly to maximize profits, 49% specified bitcoin, versus just 37% for gold.

LendEDU Director of Communications Mike Brown says Bitcoin is up roughly 68,189,500% since its start in 2009, while gold is up 105% over the same period.

“Gold is proven as a reliable investment and safe haven against market volatility and inflation, which is especially relevant in 2021. Bitcoin is becoming a competitor for just the same thing, although its wild price fluctuations are not for the faint-hearted and attract a younger, more aggressive investor … We found gold is still trusted for more cautious investing, especially amongst older Americans, but bitcoin is closing that gap and is preferred for speculative investing, especially with the younger crowd.”

LendEDU’s Mike Brown

Brown says the survey results were “none too surprising; bitcoin has periods of monumental gain that make it a salivating buy for aggressive investors trying to make a profit. But it also has periods of monumental loss and faces constant regulatory and institutional scrutiny that make it a questionable buy if your first investment priority is protecting the money you already have.”

Gold, on the other hand, doesn’t have eye-popping surges like bitcoin but is safe and has historically delivered steady profits to the patient investor looking for a financial safe haven.

The survey reveals a younger bias towards bitcoin and an older population favoring gold. Thus, 56% of those between the ages of 18 and 24 thought bitcoin was the better speculative asset, while 29% thought gold was. The percentages were 29% and 55%, respectively, for poll participants over 54.

Similarly, 42% of the 18 – 24 cohort thought bitcoin was a better store of value to protect against inflation, while 44% said gold. For the over 54 cohort, those percentages were 16% and 67%, respectively.

Brown found the 35-44 age group surprising as they were quite bullish on bitcoin in all four questions and broke with the normal trend that had older respondents favoring gold and younger ones opting for bitcoin. “This could be due to this demographic getting in on bitcoin in the extremely early stages, around 2010 when they were in their mid-twenties or early-thirties.”

When asked if they have invested in bitcoin or gold recently amid concerns about inflation, 15% had invested in gold, 31% in bitcoin, 15% in both, and 36% in neither.

For retirement investing, gold still holds a dwindling edge

In another part of the survey, poll participants were given four increasing monetary values and asked if they would rather invest each value in either bitcoin or gold to build a retirement nest egg that they couldn’t touch until retirement. In nearly every scenario, gold was the preferred retirement investment choice over bitcoin. Only when $1,000 was the starting amount did more respondents (47%) want to invest in bitcoin over gold (43%).

But as the starting amount went up, so too did the risk, which is likely why respondents switched over to the less-risky, less-volatile gold to start building their retirement nest eggs as the questions progressed. As Brown notes, “Retirement accounts should be stable, and you’ll lose a lot less sleep investing $50,000 in gold instead of $50,000 in bitcoin.”

Even so, no matter the initial investment amount, most age groups preferred building their retirement nest egg through bitcoin rather than gold. For example, 46% of the 45-54 cohort wanted to invest $50,000 in bitcoin compared to 41% who said gold. Continue Reading…