Do fad investment opportunities do more harm than good for your portfolio?
07/07/2021Investing is a favoured tool of UK residents for boosting their wealth, with an estimated 15% of the total UK stock market held by individual shareholders.
While most investors tend to target slow and steady returns over a period of years, other contrarians look elsewhere for ways to maximise returns.
You may have seen one such opportunity in the news earlier this year. GameStop, an American video game retailer, saw a spike in its share price as a group of investors looked to cash in on the stock by betting against Wall Street hedge funds.
However, fad investment opportunities like this may be less of a chance to make a quick buck, but, rather, more of a risk to your money.
GameStop will have been lucrative for some – but less so for others
While it isn’t the first event of its kind, the GameStop short makes for an interesting case study.
In January, a group of retail investors on an online chatroom called “Wall Street Bets” on social media site Reddit developed a plan to make some money in the market by punishing a few US hedge funds.
The hedge funds had “shorted” GameStop, essentially betting that its share price would fall. If it did go down, which it looked more than likely to do, the hedge funds would make a lot of money. However, a rise in the price would put them severely out of pocket.
The investors on Reddit saw what the hedge funds were planning and enacted a “short squeeze” – buying shares to drive the price artificially high. This left many of the early Reddit investors with shares in GameStop that had risen nearly 800%. Meanwhile, the hedge funds shouldered around $13 billion in losses.
This chart shows how volatile GameStop’s share price was in the first quarter of 2021:
Source: Google Finance
However, the darker side to these returns is the number of people who got involved after the share price had already risen, buying into something they didn’t understand.
GameStop peaked at $347.51 on 27 January. But by 4 February, it was worth just $53.50. For some, this was life savings on the line, potentially lost forever.
The price has risen again since but has reached nowhere near its previous peak. As Mark Taylor, a sales trader at Mirabaud Securities, puts it:
“As the cheerleading and rage against the machine dies down, the man on the street is left holding the bag again.”
Cryptocurrencies may present just as big a risk
Another currently popular investment trend you may have seen is in buying cryptocurrencies such as Bitcoin.
Bitcoin is a digital currency, decentralised from government banks. Using what’s known as “blockchain technology”, it’s a (supposedly) entirely secure currency that cannot be counterfeited, as a public ledger records every single transaction made.
Returns on Bitcoin in the past year have been impressive, rising to a high of $60,743 in March 2021.
However, while it may well be the future of all money, Bitcoin is a potentially dangerous investment: it’s volatile, has no inherent value, and there’s currently no precedent for returns.
Source: Coindesk
Bitcoin was enjoying an all-time high until it took a tumble in May 2021. And, as you can see in the graph above, previous spikes have been followed by rapid declines. Seeing as Bitcoin creates no value outside of itself, there’s no guarantee that you won’t lose your entire investment overnight.
In other words, buying cryptos is not investing, but gambling.
Traditional options present a statistically safer choice
Fad investments appear to offer huge returns in a short amount of time, but also come hand in hand with the risk of losing your entire investment.
Meanwhile, traditional stock options in global markets can present a far safer home for your money.
Analysis of the FTSE 100 by IG found that the total return for the index over the last ten years was 103.98%, presuming that dividends were reinvested. Of course, while some years were more favourable than others, that stacks up as an annualised return of 7.38%.
The FTSE 100 has consistently bounced back from periods of economic turmoil, too. And, while there’s still some distance until the market fully recovers from the impacts of coronavirus, the data does already appear to trend in that direction.
Source: Google Finance
Small, steady returns over a period of time can generate strong cumulative returns. And the longer you hold the investment, the less chance there is of losing money at all.
Investment platform Nutmeg found that the probability of risk for investors buying stocks in the global markets improved year on year, culminating in a next to 0% chance of loss after around 13 years of holding an investment.
Source: Nutmeg
Your decisions in constructing your portfolio can be impactful here. A balanced, diversified investment strategy with stocks in different industries and countries can help offset losses if one stock does particularly badly in a month.
Bear in mind, past performance does not indicate future performance. Your investments can fall as well as rise, and you may get back less than you invest.
Combining strategies
Overall, investment fads likely present a danger to your money more than they do an opportunity. A well-balanced portfolio made up of a range of investments will nearly always give the greater chance of returns over the long term than a punt on a long shot.
Strangely, this does mean that some investment fads do offer a quasi-diversification for your investment strategy, providing that you don’t rely on them entirely.
Bitcoin was created in 2009 with a price of $0, and even in 2011 it was possible to buy for just $1. A single Bitcoin bought for $1 ten years ago would have been worth $60,743 at this year’s peak and is still worth $34,096 at the time of writing. Considering how small an investment that would have been, it’s hard to call it a bad choice in retrospect.
However, if you really are set on investing in opportunities like this, you must do so in the knowledge that the potential exists for you to lose your whole investment.
Just as it wouldn’t be sensible to put your life savings on a flutter at the Grand National, treat these opportunities in the same way. Think of them as a gamble; it would be great if they came off, but there’s a distinct possibility that you’ll end up out of pocket.
Need help with your investment strategy?
If you’d like help designing an investment strategy with the right level of risk and reward for you, please contact us at Douglas White. Email info@douglaswhiteltd.com or call 0151 345 6828.
Please note:
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
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