You have likely heard a lot about Game Stop, Robinhood, and Reddit over the past week. If not, the short version is this: There is a group on Reddit called WallStreetBets that makes recommendations on how to invest. The group promoted Game Stop’s stock to its followers, many of whom have accounts on the investing app Robinhood. Investors on Robinhood, who aren’t well known for having investing experience, began pouring money into the troubled stock, driving its price up dramatically. As the stock price soared, professional investors who had been betting against Game Stop started losing money, with some hedge funds losing over half of their value. Trading platforms including Robinhood and Schwab responded by temporarily halting purchases of Game Stop which infuriated their investors and drew criticism from both sides of the political aisle. The story became about Game Stop buyers, positioned as the little guy, versus Wall Street. That’s not the story that I take from these events. What I see are two lessons on how not to invest. Robinhood has touted itself as democratizing investing, claiming to have opened up access to investing by not charging for trades. They attracted people to their platform by giving them a free share of stock, nurturing the idea that individual stocks are the way for nascent investors to get into the market. Individual stocks are inherently riskier than investments like mutual funds and ETFs which invest in hundreds or thousands of companies. This is especially true for investors with less money to invest because they can’t afford to buy enough individual stocks to achieve proper diversification. Also troubling is the emphasis that Robinhood puts on free trades, which encourages more frequent trading and market timing, neither of which are correlated with higher performance. New investors can just as easily buy a well-diversified mutual fund with no trading cost as they can invest with Robinhood, which makes their white-hat claims of opening up investing to the masses difficult to accept. On the other hand, we have professional hedge fund managers. Hedge funds are also fraught with higher risk because they make sizeable bets (read: guesses) about how the market will perform in the future, just as they bet that Game Stop would fall in price. Their hunches are often fueled by practices like shorting stocks, or borrowing money to invest, which further increase risk. Though hedge funds have not regularly demonstrated an ability to outperform the market, they often charge hefty fees equal to 2% of the money invested plus 20% of the profits. The bottom line: this is another risky and expensive way to invest. Though I find it intriguing to consider how social media will impact the future of investing, and I do think there are legitimate questions about pausing the trading of certain stocks, I’m not particularly interested in the David and Goliath theme that has been attached to these events. It distracts from the more important point, which is that both groups of investors were encouraged to take unhealthy amounts of risk. Well-diversified, low-cost, disciplined investing doesn’t often make the news. That alone is a sign that we are doing something right.
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