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Investing Isn't Gambling

Don't put your savings on the line trying to guess what the herd will do next, as we saw with GameStop this week.

Sarah Newcomb 27 January, 2021 | 5:50PM
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Gambling

As someone who specializes in consumer and market psychology, watching the GameStop' "microbubble" in real time is fascinating. What's so interesting to me is that the short squeeze that Twitter and Reddit groups have orchestrated is an example of when the value of a stock changes (temporarily) for reasons that are unrelated to the fundamental value of the company. So we're, in a sense, able to watch the pure effect of human psychology on the market value of real assets. It's fascinating and fun to watch.

But what's happening here? Put simply, a group of investors got organized and found a few companies whose price they could manipulate if they acted en masse to create a microbubble, if you will. Playing the game of price arbitrage is, in this context, both legal and fun, but it is also based largely on speculation about human behavior, not underlying value. Wise investors will see it for what it is: a temporary price adjustment based on nonfundamental factors. Some people like to keep a small portion of their money in brokerage accounts for exactly this kind of speculative event, but just like you wouldn't take your rent money to Las Vegas, don't put your life savings on the line trying to guess what the herd will do next. In other words, play safe. If you can't afford to be wrong, don't make the bet.

This event has been interesting from a cultural perspective as well. In this case, a smallish group of individuals managed to pull off a coordinated market event that has made and broken a few real fortunes. It could catch on, and we may start to see things like this happen more often as people try to organize other such events in their own favor. Again, wise investors can avoid having these things adversely affect their own portfolios by the usual means: well-diversified funds and long-term holding periods, to name two. Large-cap stocks are also less vulnerable to being manipulated because of their size.

Speculation is fun. It's why a lot of people love investing, and if you speculate with only moneys you can afford to lose, events like these can be exciting and sometimes profitable. Still, if you are new to investing, don't understand the difference between fundamental value and market price, or you are considering putting money on the line that you need for your present or future security: stop, breathe, and walk away. No crowd of anonymous Redditors deserves your life savings, period

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About Author

Sarah Newcomb  Sarah Newcomb, Ph.D., is a behavioral economist for Morningstar.

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