We frequently hear variations of the similar question: “Should I invest in 3-D printers?” or “I heard on TV that ‘Company X’ stock is set to take off, should I buy?”
The current shiny object is the eye-popping growth in the value of bitcoin and other cryptocurrencies – digital money enjoying increasing popularity as an alternative to traditional banking. And as more states legalize marijuana, there is a lot of buzz about “pot stocks” – tiny new companies trying to take advantage of a growing market. All puns intended.
Whatever the trendy new investing opportunity, our response is the same.
First, a new industry or freshly launched company stock is a speculative investment with a relatively strong risk of loss. Speculative investments may have little or no track record, little diversification or additional types of risk that make them unsuitable for many investors.
To be clear, the broader well-established investment markets still carry risks, including fluctuations in value or even loss.
But with these latest speculative investments or the contraption your uncle invented in the garage, the risk is greater for major price fluctuations or losses. Liquidity is another potential problem for a thinly traded investment, as you may wait a long time for a buyer when you’re ready to get out.
However, you could make a killing if you pick the right pot stock or cryptocurrency at the right time. The problem is that stock picking and market timing generally don’t work, as shown by decades of academic research.
Think back to the Betamax v. VHS videocassette era. Which would you have chosen as an investment before knowing the outcome? Your chance of winning would have been a coin flip. Which of the hundreds of internet companies would you have added to your portfolio in the late 1990s as the tech bubble inflated? Which ones are still standing? Your odds there were perhaps much worse than a coin flip.
The problem with trying to outsmart the investment market is that publicly traded U.S. securities are strictly regulated, with issuing companies required to provide very specific information at specific intervals, such as quarterly reports. Additional “insider” information-sharing is strictly prohibited. Management shakeups in the news or new products add widely available information to official company reports. So generally all investors have access to the same information at the same time, by law.
Thousands of professional investment managers around the world then analyze that data to determine what they believe to be a fair price. Thousands of resulting trades set the price of a given stock from moment to moment, as new information comes out over time. This includes information and opinions shouted by people in rolled-up sleeves on cable TV shows.
To beat the market, you have to outperform the average of tens of thousands of investors around the world, all working from the same information. Do you think you are smarter or luckier than those thousands of traders, most of whom are professionals who analyze and trade stocks and currency markets all day for a living? If not, proceed carefully.
If instead you simply buy a broad basket of stocks and bonds using mutual funds or ETFs – a total-market fund holding a large swath of securities – you will essentially be accepting the collective expertise already at work within the markets. You also will likely end up owning a portion of newer industries and companies that have profited their way onto the major securities exchanges, possibly including pot stocks and cryptocurrencies.
Other examples of speculative investments include art, collectibles, thinly traded small- or microcompany stocks in any industry, and gold and other precious metals.
The unexpected small crash of bitcoin values in December, and the U.S. attorney general signaling a possible return to more aggressive enforcement of marijuana laws, should give pause to even the bravest speculator thinking about cryptocurrencies or pot stocks.
Treat speculative investments as you would any individual company stock: A good rule of thumb is not to put above 5 percent of your portfolio into any single potentially volatile asset, including the current flavor of the week.
Certified financial planner Kenny Gott is president at Piatchek & Associates and author of the book “Bottom Line Financial Planning.” He can be reached at KGott@PFinancial.com.
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