Gamestop stock has soared more than 1,750% over the past few weeks, led by an army of Robinhood traders utilizing sites like Reddit and WallStreetBets. These social media warriors knocked one hedge fund manager to its knees as Gamestop soared to dizzying heights. The day traders forced Melvin Capital to cover its losing trade, and as a result, they needed about $3 billion from Citadel and Point72 to “shore up the fund.”[1] David versus Goliath.

In 1999 I managed a Morgan Stanley office. Morgan Stanley was, and is, an enormous banker for IPOs, and during the height of the tech-boom, they brought hundreds of companies public. I had a front-row seat to the feeding frenzy. The firm introduced a commission-free trading account called Choice, and it unleashed pent-up demand for traders. Some individuals made hundreds of trades per month, trading popular stocks like Qualcomm. From March 1999 to January 2000, it jumped 1,700%, but two years later, it fell to $12, dropping 87%.

Qualcomm was not flying solo. In 2000, Microsoft, Cisco, Qualcomm, Intel, and Applied Materials were the day’s darlings. An investment of $10,000 ($50,000 total) to these companies in 2000 fell to $29,903 in 2017, a drop of 40% over seventeen years! It took more than fifteen years to recover your initial investment for most of these companies, and Cisco Systems is yet to reclaim its historical high reached in April 2000.

At some point, valuations matter, and investors will focus on earnings, revenue, cash flow, and profits; until then, tread lightly and be careful with these high-flying investments.  As Mark Twain said, “History doesn’t repeat itself, but it often rhymes.”

I’m a believer in capital markets, and the less regulation, the better. Buyer beware. If investors make money trading speculative stocks, so be it. But, I don’t want to hear them complain when the market corrects, as it always does. It might appear the best way to make money investing is during a bull market when stocks are trading at all-time highs, but this is not true. A bull market will enhance your wealth, but it won’t create it.  To build your fortune, invest in stocks during a bear market. During the dark days, prices are cheap, unloved, and undervalued – an ideal time to buy stocks.  If you’re patient, you will have an opportunity to purchase a basket of quality companies at lower prices.

The rise of a few speculative stocks like Gamestop, FuboTV, Bed Bath & Beyond, Virgin Galactic, Nikola, Tesla, Palantir, and so on may cause you to rethink your investment strategy. Don’t abandon your plan to chase momentum stocks because a momentum strategy ends quickly, without warning. And when it does, it won’t be pleasant. Have you ever played musical chairs?

After graduating from college, I bought a few thousand shares of a penny-stock from my roommate. I speculated with money I didn’t have, and I lost it all. It hurt me financially, but it was a reason why I entered the investment business. I wanted to learn how to manage my own money for the long haul, and I’m thankful I learned a valuable lesson when I was young and dumb.

I often think it’s easier to make 100% on a short term trade than earning 7%, 8%, or 9% for decades. It’s possible to get lucky in the near term, but it takes courage, patience, wisdom, and fortitude to hold stocks for generations.

If you’re experiencing FOMO and want to invest in a few YOLO trades, here are some ideas to help you with your trading.[2]

  1. Limit your trading capital to 1% to 3% of your investment assets. Do not use retirement funds to speculate on stocks with weak balance sheets. Don’t gamble with money you can’t afford to lose.
  2. Do not use margin to buy stocks. Leverage works when stocks rise, but it will kill you when they fall. While at Morgan Stanley, a broker had an account go negative because of a margin call. The client used leverage to speculate on stocks, and when they fell, he lost all his money, and he needed to deposit a check to cover his debit balance.
  3. Take gains if you made big money in the short term. Selling half to three-quarters of your original position is prudent, allowing you to diversify your assets and stay invested. You want to live to see another day.
  4. If you have never traded options, don’t start now. Options are derivatives of stocks, and if you’re not careful, you can lose money quickly. They’re wasting assets, and you must be right on the company, the direction, the timing, the price, the strike price, and the expiration date. If you want to wade into the options market, hire an advisor with years of trading experience.
  5. A financial plan or investment policy statement will keep you focused on your long-term goals. Review and consult your plan often if you feel like you’re missing out on extraordinary gains; chances are, you’re not.

Investors with enough money are less likely to chase returns, hoping to cash a winning ticket. They’re content with their holdings and don’t feel like they’re missing out on the party because they have a plan, and, more importantly, they follow it. If you’re speculating to create wealth, it will evade you like a lottery ticket. It’s better to grow rich slowly than to try and get rich quickly.

Be patient, follow your plan, think generationally, and good things will happen.

Wealth gained hastily will dwindle, but whoever gathers little by little will increase it. ~ Proverbs 13:11

January 27, 2021

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.

Data Sources: YCharts

[1] https://www.marketwatch.com/story/hedge-fund-melvin-capital-closes-out-gamestop-short-cnbc-2021-01-27, 1/27/2021 by Willam Watts

[2] FOMO = Fear of missing out; YOLO = You only live one.