Last updated on April 8th, 2021 at 08:58 am
Stop me if you’ve heard this one: A global health crisis, shifting politics and social unrest have wreaked havoc on the stock market. That same health crisis has kept people home for an entire year, causing them to spend more time watching the news and browsing social media. Meanwhile, apps make it easy to trade online and trading fees have evaporated. Throw in some extra cash in the form of stimulus payments, and you have the makings of a wild ride.
The truth is, none of us has seen this scenario before, said Michael Antonelli, managing director and market strategist of Milwaukee-based Robert W. Baird & Co.’s private wealth division. The market is more accessible than ever but also more volatile than ever.
“It’s easy to get into trouble when you’re in waters that you don’t understand how to swim in,” he said.
GameStop is the latest and flashiest example of a “meme stock,” when a stock catches fire on social media and starts building off its own hype. Other companies caught up in the craze are AMC Entertainment Holdings, whose revenue plummeted during the pandemic as people stayed away from movie theaters, and Milwaukee-based headphone maker Koss Corp.
Experts say if you want to jump on the “meme stock” bandwagon, or just try your hand at self-directed trading, you should know your appetite for risk, create clearly defined goals and work with your financial adviser to determine how retail trading can fit into a well-rounded financial plan.
The GameStop craze started on Reddit, a social media platform, as retail traders using the Robinhood app drove the stock price up to squeeze hedge funds that were short selling it. As the stock soared, more traders jumped on the bandwagon, driving the price even higher. The price crashed after Robinhood restricted GameStop trading but started climbing again a few weeks later.
Much of the motivation for these bandwagons is “FOMO”: Fear of Missing Out, Antonelli said.
“It’s really hard to watch other people get rich and not want to join in, especially in this version of the world where throwing money at something requires pushing a button on a phone,” he wrote recently on his blog, Bull & Baird. “Magnify that by the fact that we are ensconced in a 24-hour social media cocoon where people flaunt their ‘gainz’ like they are Cortez who just discovered the New World.”
But when your co-worker tells you he made $11,000 in two days by investing in GameStop, keep in mind that he probably isn’t telling you about the times he bets big and loses, said Jeremy Pawlak, a Milwaukee-based financial adviser with The Pawlak Prochnow Group.
“We’re all victims to our own sets of personal biases,” he said. “The appetite for upside volatility is not equal to our appetite for downside volatility.”
Whether it’s trendy stocks like marijuana-based businesses, IPOs like Roblox and Bumble, or cryptocurrency like Bitcoin, the media feeds into the frenzy.
“It literally is like going to Vegas with bells and whistles and alarms and cheering and clapping,” said Julie Ellenbecker-Lipsky, president and senior wealth adviser at Ellenbecker Investment Group Inc., Pewaukee. “That is not sound financial management. It’s entertainment.”
Not that there’s anything wrong with going to Vegas, if you can afford to and know your limits, she added.
“It’s fun for some clients,” she said. “But with any kind of gambling, you have to be willing to weather the loss. You don’t gamble everything you have.”
Put another way, a financial plan is like a baseball game, she said. Speculative investments are like swinging for the fences – sometimes you hit a home run, but you often strike out. You also need reliable base hitters and benchwarmers – and don’t forget about coaches.
“Whatever amount you want to trade on your own, and you want to try to follow trends and fads, that has to be an amount you’re willing to strike out on,” she said.
If you still want to swing for the fences, here is some advice from local financial advisers:
Know your tolerance for risk
“The most important thing to keep in mind is the risk you’re willing to take,” Ellenbecker-Lipsky said. “If you’re going to buy more speculative investments, you want to make sure you’re willing to experience volatility and potentially lose it all.”
“You have to also be willing to keep your emotions in check,” she added. “Emotions are probably one of the biggest risks when it comes to investing.”
If you can’t stomach that, playing the market might not be for you.
Do your research and form a plan
“The first thing an investor needs to do is determine whether they’re speculating or whether they’re investing,” Antonelli said.
Speculating is using a sum of money to bet on short-term movements – anywhere from a day to a year – while investing is a long-term process where you’re building a strategy to reach a goal, he said.
“I don’t know if a lot of people who are looking to gain something (from trending stocks) are saying, ‘I’m going to make a long-term portfolio out of this,’” he said.
Keep in mind the tax implications, Pawlak said. If you hold an investment for less than a year, you will be taxed on the gains at your ordinary income rate. If you sell after more than a year, you pay the lower capital gains rate.
It’s also important to know the difference between a market order, which places an order for a stock and pays the next available price, and a limit order, which sets a maximum amount you are willing to pay, Pawlak said.
“When the market is really volatile like it has been, you may be paying a lot more than what you see on the screen,” he said.
Make sure you set parameters for selling the stock as well.
“A lot of people make the mistake of buying something without a good plan for how to get out of it,” Pawlak said.
Don’t forget to coordinate the trading account with your estate plan so it goes to the right beneficiaries if something happens to you, Ellenbecker-Lipsky said.
“You don’t want to have this side account that is not going to pass the way you want it to pass,” she said.
Work with your adviser
While the advisers don’t encourage clients to trade on their own, they said they can help clients set up a trading account and fit it into their financial plans.
“We set them up in a way that we can view what they’re doing and walk them through the process the first couple of times,” Pawlak said.
It’s important to disclose your trading to your adviser so if you’re taking a lot of risk, your adviser can develop a core plan that minimizes risk in other investments, Ellenbecker-Lipsky said.
“An adviser can still be helpful for you if they understand what your goals are, and you can use them as a sounding board,” she said.
An adviser can help you stick to your plan when your emotions start getting the better of you, Antonelli said.
“Build some guardrails around yourself such that you aren’t your own worst enemy when it comes to investing,” he said. “Greed and fear are human emotions that we all experience, and they can overwhelm rational thought.”