GameStop stock has fallen back to earth. But the WallStreetBets group on Reddit helped launch it like a rocket — late in January, the shares spiked up 1,910% from earlier in the month. Some people in the group made money if they got out at the right time. A few became wealthy in a life-changing way.
So, has the power of social media changed the investing world? Is it possible to join an investing messaging board and strike it rich on the next hot stock pick?
Sadly, probably not.
"We'll see if they can create lightning in a jar a second time," says Barry Ritholtz, chairman of Ritholtz Wealth Management. "But I would be skeptical they're going to take anything from $5 to $500 anytime soon."
Ritholtz helps manage about $2 billion on behalf of clients. So we talked to him and put together four things to know about this GameStop phenomenon and how you can be a smart investor.
1. What we just saw with GameStop was extremely rare.
"GameStop surely looks like something that was a unique combination of elements," says Ritholtz. "This was very much the perfect storm."
Ritholtz says the stock took off for various reasons. Enthusiasm on Reddit most likely lit the fuse to get the stock rising. That caught some hedge funds in what's known as a "short squeeze." Hedge funds placed big bets that the price of GameStop would fall. When their bets backfired, they were forced to buy back the stock at a higher price. A chain reaction of forced-buying drove the price into the stratosphere. Ritholtz thinks some big professional money got in on the game, too, helping to further juice up the stock.
But the huge pop and the sudden crash was dramatic, highly unusual and weird. And that's partly why it's unlikely to happen again soon.
2. Markets are "a learning machine."
"Markets seem to operate almost as a learning machine," says Ritholtz. "They're highly adaptable and tend not to see the same mistake happen frequently."
Markets are made up of human beings making trades. During the GameStop stock craze, some hedge fund investors got burned, caught a vulnerable situation. So they learn, and the overall market learns.
So, that too is why trying to ride the next Reddit rocket ship probably won't work.
But, fortunately, there's a more reliable strategy.
3. Don't try to pick individual stocks.
Here's a time-tested truth. It's too difficult to pick stocks that will be winners. Even professionals at mutual funds usually can't do it well enough to justify the fees they charge you. Around 85-90% of the time they fail to outperform the market over time.
Trying to get in and out of stocks quickly, through day trading or buying so-called options on stocks, can be a lot riskier than buying shares for the long-term. In that kind of frenetic action, everyday investors are outgunned.
It's like dressing up for ultimate frisbee with a headband and shorts, and going out on the field to play in an NFL game. That wouldn't end well. "When you are buying and selling against high-frequency traders and momentum hedge funds, you are playing against Super Bowl-level people," says Ritholtz.
But, he says, you do have a different sort of advantage. Professionals must try to justify their fees and their existence by attempting to beat the overall market. You don't.
4. Don't play Wall Street's game. Buy index funds.
You can strike back at Wall Street by not playing its game. Instead, buy broad-based index funds. Doing that will let you own a slice of the entire stock market at a very low cost. Combine that with low-fee bonds and perhaps a real estate fund to build a well-balanced diversified portfolio. History shows that approach offers the best returns.
Your financial advisor might tell you to buy some actively-managed mutual fund, where the fund managers try to pick stocks to beat the market. Some advisors get paid more money in commissions if they get you to do that. But don't do it. The titans of investing and finance — including Warren Buffett, David Swensen (who manages Yale's endowment), the late Jack Bogle (who founded Vanguard), and economist and Nobel Laureate Eugene Fama — they've all concluded you are better off in index funds, so-called "passive" investing, than you are picking stocks or paying someone to pick stocks for you.
If you want to buy and sell some individual stocks because you think it's fun — some money managers will tell you that's fine, but you should make it a small slice (5% or less) of your portfolio. And remember, the odds are that over time, your stock picks won't beat the overall market.