Allworth Co-CEO Pat McClain explains what you need to think through before investing in something new.
Disco. Pet Rocks. Rubik’s Cubes. Big hair.
Those are some popular fads from the 70s and 80s.
Fads come and go. And while the fads above are mostly harmless (well, except of course, for disco), one that concerns me right now is the excitement surrounding what I call 'fad investments.'
Fad investing occurs when someone purchases an overhyped equity without understanding the underlying principals or outlook of the company or entity that is producing or issuing the stock.
It's certainly nothing new. But it’s increasingly common.
Some of the reasons that fad investing has exploded are the low interest rates on alternative investments such as bonds, the fact that anyone with a computer or smartphone can trade, the fear of missing out (which I’ll cover below), and even the extra amount of time that many of us are spending in front of computers during COVID.
The difference between investment fads and trends
Investment fads are characterized by excessive enthusiasm or buzz.
For instance, the dotcom bubble was chock full of fad investments as millions of investors, star struck with visions of El Dorado, were automatically more enthusiastic about any stock that had a connection to the Internet.
The result was that billions of dollars in life savings were poured into thousands of long-forgotten dotcoms, even when those start-ups were nothing more than grandiose concepts pitched by articulate wunderkinds.
This is not to embarrass people who have gotten caught up in fad investments. Millions of highly intelligent people did (and do), and the odds are that you, or someone you know, have lost money on one.
Conversely, trend investing is the investment in stocks, industries, or markets that are logically expected to boom in the future. An example of a trend investment would be electric cars (which, of course, doesn’t mean that investing in electric cars is going to be profitable).
Ideally, a trend investment offers a solution for a real problem that meets a need and does it (or hopes to do it) better than it’s been done before. A fad investment is something exciting, fun, or even cool. And while it could eventually be a good investment, fads are typically defined by having style over substance.
Fad or trend, the key is to avoid hype and to treat every investment dispassionately.
So, if you don’t have a fiduciary advisor, what should you ask yourself before adding any stock to your portfolio?
Stick to the essentials. Among many other questions, here’s what you should ask:
Will my financial situation be adversely affected if the outcome is not what I expect?
Is the investment going to add something worthwhile to my portfolio that I don’t already have?
If I buy it, can I expect that it will:
Increase my returns?
Decrease the volatility in my portfolio?
Help me achieve my financial goals?
If you can’t answer yes to these questions, then it’s time to slow down and think a little more about what’s motivating you.
The psychology behind avoiding bad investment decision making
One way to help avoid bad investment decision making is to remove emotion from the equation. (And this applies to any investment, whether it’s a fad or Apple.)
You can help protect yourself from making a life-altering financial mistake by familiarizing yourself with the motivations that drive investment behavior.
Think of it this way: fiduciary advisors work with you to dispassionately invest your money. That means that they not only should be immune to the hype and headlines, but that they will ask you questions that should illuminate your motivations for wanting to invest in the stock in the first place.
Simply, there could be emotional blind spots in your reasoning.
Whether it’s on one of our radio podcasts, or at a financial planning workshop, whether you choose to work with one (or not), I always recommend that you speak to an experienced, fiduciary advisor (someone who is legally and ethically bound to serve only your best interests) before you take the plunge on an exciting new investment.
You may not like the answers, but they very well may save you from making a terrible mistake from which you can’t recover.
Fad, trend, or Fortune 500 company, when it comes to pulling the trigger on an investment, never see it as the “next big thing.” See it as an investment that comes with risk. Accept that you are human, and therefore prone to making emotional decisions.
Then step back and ask yourself these questions:
Am I afraid that if I don’t invest in this stock, I’m going to miss out?
Have I been convinced, or have I convinced myself, that it’s a “sure thing?”
Have I spent more time looking for confirmation that it’s a good investment than I’ve spent looking for information about why it might be a bad one?
And have I “jumped” into investments in the past too quickly, only to be disappointed?
If you’re considering an investment, especially one that qualifies as a fad or a trend, and you answered “yes” to any of the above, while that doesn’t automatically make it a bad investment, it should alert you to the role that your emotions are playing in your decision making.
And that should motivate you to take a long, deep breath, and think it through.
Remember, every investment poses risk. Every. Single. One.
And remember, when it comes to money, for most people, the pain of loss is a more powerful and lasting emotion than the thrill of gain.
Lastly, I’ve been advising for a long time. And one of the most important things I do for clients isn’t to help them discover investment fads or trends that take off. It’s helping them to avoid the ones that don’t.