How to define investment fads and why you must avoid them

Allworth co-founder Pat McClain explains fad investments and how a fiduciary advisor helps you avoid them.

You have certainly heard the term “investment fads,” but what are they and how do they work?

Investment fads are characterized as investments that realize large short-term gains and then suffer unusually quick declines. Fueled by hype, they typically appear with a bang, quickly rocket up in value for an abbreviated period – practically everyone wants in – and then, poof!

The bubble bursts and the gains disappear.

I’d like you to consider the dotcom bubble for a moment. Everyone reading this has an idea of what it was. In fact, some of you may have been hurt by investing in popular dotcoms back in the mid-90s. Others reading this surely worked for one of the many startups.

But most people I speak with tend to only consider the impact of the collapse of that bubble, and not the fairly simple dynamics that led to its implosion.

It was only roughly 25 years ago that household computers proliferated. And with them, there was a massive increase in start-ups due to the exponential growth of internet adoption.

Between 1995 and 2000, the National Association of Securities Dealers Automated Quotations, or NASDAQ, grew by 800%.¹ Venture capital flooded the industry, and just about any online company, no matter how ridiculous the concept, was able to secure financing. The influx of cash meant there was a lot of money for marketing, and those big marketing budgets created excitement, and that drew investors.

These companies gave stock away to employees like it was candy, and for a brief period, there were a great many dotcom “millionaires.” (On paper, at least.)

Unfortunately, by 2002, the NASDAQ had declined 740% from its peak.

Investment fads and investment trends are often confused, but they are not the same. Trends have more staying power and are usually based on sound investment principles.

So, briefly:

• Investment fads are when an asset or a stock’s value is driven more by hype or bad behavioral finance than by sound investment principles
• Fads differ from trends in that investment fads are not sustainable

What are two of history’s most destructive investment fads/bubbles?

Dutch Tulipmania, also known as the Dutch Tulip Bubble, occurred from 1634 to 1637, when sea-faring Holland was among the richest countries on earth. During this frenzy, a person could trade a “broken” tulip bulb (a bulb that produced a tulip with flame-like stripes) for a central Amsterdam mansion.

Legend has it that the entire collapse of the Dutch Tulip Bubble, and Holland’s ensuing economic depression, occurred when a much-anticipated deal for two rare bulbs unexpectedly fell through at the last second.

The Bull Market of the Roaring 20s was another era famous for fad investing. Due to rapid economic expansion, a dramatic (by 1920s standards) ascension of the stock market, and subsequent massive consumer borrowing in support of reckless investing, once the underlying engines of that hyper-economy were called into question, panic set in, the market crashed, and bank runs and failures and the collapse of the money supply soon followed.

How can you avoid investment fads?

I can not count the number of times that I have met with clients who were excited about investing in something that was clearly a fad.

And almost as many times, I have been able to explain to them why that investment was a bad idea.

I often say that the most important job I have as an advisor, and, in fact, the most important function of any advisor, is to keep clients from making mistakes from which they cannot recover.

And keeping folks from putting their hard-earned savings into an investment fad is my favorite part of my profession.

With all the noise, how do you resist succumbing to the herd mentality of behavioral finance and avoid chasing fad investments?

Work with a fiduciary advisor.

If a client can communicate to me what they would like to achieve with their investments, and what their short- and long-term financial goals are, I can build them a plan that can help them reach those goals.

I have met with a lot of people over my 30-years as an advisor who could have used the help of a dispassionate partner, but who did not realize the breadth of the services we provide, nor how that breadth creates a braid that can greatly improve a person’s overall financial well-being, until it was late in the game.

Far too many people believe that an advisor does little but invest money, which could not be further from reality. And while investments are an important part of what we do, it’s just a part of the value we fiduciary advisors provide.

Among other services, your advisor should offer:

• Integrated financial planning that considers all your assets and liabilities
• Forward-thinking, money-saving, tax planning
• Estate planning recommendations
• Personalized investment management
• Behavioral financial guidance
• Social Security planning

If you are thinking it might be time to partner with an advisor, or at least get a second opinion about your investments or your retirement readiness … it is.

We offer complimentary, no pressure, first-time appointments, where you will get your financial situation evaluated by an experienced, fiduciary advisor.

Let us explain how we can help you.

^{1 Dot-com bubble - Wikipedia}