The Risks of Do-It-Yourself Investing
Struggling electronics retailer GameStop made headlines in early 2021 when its stock price soared seemingly overnight. While hedge fund managers were shorting the company (basically, betting that the stock price would go down), novice investors were following leads from Reddit and buying up GameStop stock en masse and pushing the price up and selling for a huge profit.
As a result, mobile investing apps like Robinhood and Acorns saw a surge in popularity, with Robinhood briefly becoming the top app on the Apple app store, as many other inexperienced investors decided they would try to get in on the action as well.
The recent proliferation of investing apps has made it cheaper and easier for novices to jump on the investing bandwagon with no expert guidance. But amateurs hoping to score big returns on the next hot stock could be setting themselves up for big losses instead
We talked with Tom Martin, CFA, a senior portfolio manager with GLOBALT Investments (a wholly-owned subsidiary of Synovus) about the perils – and possibilities – of stock investing for individual investors.
What happened with GameStop
Based on the social media frenzy whipped up on Reddit, GameStop stock1 surged from around $17 per share at the start of 2021 to a high of almost $350 on January 27. This was great if you happened to be one of the people who bought shares for $10 or $20 and sold them for $200 or $300. But it wasn't so great for people who bought at the top of the market, who lost almost all of their money when the price fell back to earth. (By mid-February the price had fallen back down to $40 per share.)
A cautionary story in the Wall Street Journal2 highlights one 25-year-old security guard who got caught up in the frenzy, took out a personal loan with an interest rate of more than 11%, and used that money to buy GameStop stock – at a cost of $234 per share. (WSJ reports that he's holding on to his shares, hoping they will rebound; in the meantime, he's making monthly payments on his loan.)
Unless there is another social-media-fueled buying frenzy, that rebound seems unlikely.
"The price of a stock should ultimately reflect the future prospects of that company. That's what was happening when GameStop was trading at $3 to $5 per share [in the summer of 2020]," Martin explains. "But during January and February of 2021, GameStop wasn't trading based on the value or prospects of the company. In fact, GameStop was being shorted by financial experts because they expected the company to go bankrupt."
Understand the stock market – and risk
The biggest risk of do-it-yourself investing, according to Martin, is that you will lose money you can't afford to lose, money that would've been better spent paying down debt or saving up for a down payment on a home.
When you put money into a checking account, savings account, money market account, or CD at an FDIC-insured bank, you may not be earning high yields, but your principal is protected – up to $250,000 per person per bank.3 This means that, in the highly unlikely (but not impossible) event that your bank should go bankrupt, the government would make sure you got your money back, up to the $250,000 per person limit.
But unlike putting your money into a FDIC-insured bank, the money you put in the stock market is not guaranteed.
In order to avoid losing big by gambling on the stock market, you first have to understand how the stock market works. There are two ways you make money from buying stocks:
1. When the value of the stock goes up.
2. When the company you own stock in pays dividends.
Of course, if you "buy low and sell high," you can make a profit from buying stocks. Problem is, there's no guarantee that stock prices will go up after you buy it. In fact, it could go down and stay down for an extended period of time. This happens more often than you may think. It could be because a particular company fails or was overvalued (like GameStop in early 2021).
"A big risk with jumping into a stock-buying frenzy is that you don't really know what's really moving the prices. Unless you're in the business or studying it for quite some time, you're not going to know. Professional investors, even if they've been in business 40 years or more, are still learning every single day," Martin says. "If you spend 40 minutes researching something on the internet, you're essentially buying the stock blind."
But stock prices can go down even for solid companies whose stock is not overvalued. If you buy stocks now but need the money soon, there's a chance the stock will be worth less than what you paid for it when you need to sell it.
This can happen due to stock market volatility. This means the stock market goes up – or down – a significant amount in short period of time.
It can also happen during a Bear Market, when the entire market goes down significantly. (Think of the infamous stock market crash of 1929, the tech bubble that burst in 2000, or the financial crisis of 2007/2008.) If you need your money before the market – and the stocks you hold – go back up, you could be forced to sell your stocks for less than you paid for them.
Understand your goals
Some people are lured into investing because they want to realize a financial dream, like saving up for a down payment on a home or paying off student loans. But if you're trying to reach a shorter-term goal, investing in the stock market is not the way to go. There are no guaranteed returns – and even the money you initially put in is at risk.
On the other hand, if you're saving for retirement and don't need the money for a long time, investing (wisely) in the stock market with the help of a seasoned professional can be a great way to grow your money for the future. That's because higher risk investments (like stocks) tend, over time, to yield higher rewards than lower risk investments (like saving accounts, CDs, or bonds).
Question your sources of information
One of the biggest problems with the Game Stop surge was that novice investors were taking advice from strangers on the internet.
"If you're reading something from someone who's telling you to buy a stock, you should ask yourself: Does the person making the recommendation own the stock? And what are they trying to do by telling you to buy the stock? What do they get out of it? They aren't doing it because they want to give you a good investment idea. They couldn't care less about whether or not you make money. They're trying to make money for themselves," says Martin.
"What the people on Reddit were really trying to do was get people to buy GameStop so the stock price would go up. You can bet that they were going to be the first people to sell it once it went up a certain amount."
That created a scenario where novices were buying late – and at top dollar – and then left holding stocks that were only worth a fraction of what they paid for them.
Get professional advice
If you're a novice – or even somewhat experienced investor – you may be wondering about whose advice you should trust. The answer: a professional who is a fiduciary. A fiduciary is a person who has a legal responsibility to act in your best interest – and faces legal consequences if they don't.
Examples of professional designations that are often used in a fiduciary capacity are a Chartered Financial Analyst (CFA), a Certified Financial Planner (CFP), and a Certified Public Accountant (CPA).
Another advantage of professional advice from a fiduciary is that they can help you stay the course and steer clear of bad advice that can end up slashing your net worth. The reality is that plain bread-and-butter investing can do really well, over time. Take, for example, the S&P 500 Index. While it may experience significant ups and downs from year to year, the S&P 500 Index has increased, on average, 8% annually from 1957 to 2018.4
For those who have clear financial goals and a long timeline, the stock market can be a great tool for investing. But as you can see, there is often a big risk involved in trying to manage it yourself if you're a beginner. Synovus is here to help you manage that risk. Get in touch with one of our financial advisors if you're ready to think about your long-term goals.
Important disclosure information
This content is general in nature and does not constitute legal, tax, accounting, financial or investment advice. You are encouraged to consult with competent legal, tax, accounting, financial or investment professionals based on your specific circumstances. We do not make any warranties as to accuracy or completeness of this information, do not endorse any third-party companies, products, or services described here, and take no liability for your use of this information.
- Investopedia, "GAMESTOP CORPORATION," accessed April 13, 2021. Back
- Rachel Louise Ensign, "GameStop Investors Who Bet Big—and Lost Big," The Wall Street Journal, published February 15, 2021, accessed April 13, 2021. Back
- Federal Deposit Insurance Corporation (FDIC), "Deposit Insurance," updated September 17, 2020, accessed April 13, 2021. Back
- J. B. Maverick, "What Is the Average Annual Return for the S&P 500?" Investopedia, updated February 19, 2020, accessed April 13, 2021. Back
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