Casinos may be operating at a reduced capacity right now, but gamblers are still getting their fix. Wall Street has been overrun by thrill seekers, tired of lockdown and looking for an outlet. I’m all for someone having fun but when someone’s understanding of the term “investing” more closely relates to the definition of “gambling”, I get a little nervous.
I’ve been having an increasing number of conversations with friends that are all of the sudden interested in what I do. Or at least they’re interested in what they think I do. I can hear the excitement drain out of them as I start talking emergency funds, Roth IRAs, and diversified portfolios, instead of; SPACs, out-of-the-money calls, and GameStop. While it’s fun to focus on the wild swings of volatile individual positions, most speculators underperform the overall stock market. So how do you know if you or someone you love is becoming a day trader? Here are some of the warning signs.
“TSLA is a safe bet, every time the stock has dropped, it’s come back again”
We’ve covered volatility a few times in the course of our blog posts, but I’ll give a quick recap here. Simply, volatility measures the dispersion, or the range of possible returns, over time. The higher the volatility, the riskier the asset. While volatility doesn’t necessarily mean that an asset is bound to go down, it does give you an idea of how much an asset can move, up or down, relative to its average price.
Take Tesla for example. So far, it’s true that every time Tesla has dropped, it’s eventually turned positive again. This is a false sense of security. I’ll quote the lawyers who drew up the boiler plate investment disclaimer; “Past performance does not guarantee future results”. Let’s take a look at Tesla’s historical volatility going back to when it began trading in 2010. Over the last decade or so, Tesla’s volatility has been THREE TIMES that of the S&P 500 over that same time period. 56% vs 17%, respectively (source: finance.yahoo.com). In other words, Tesla can be considered three times riskier than the S&P 500. Hardly a safe bet.
“Holding CCIV for so long was worth the wait!”
As of the date of this blog, Churchill Capital Group (CCIV) -one of the stock market’s newly minted SPACs- has been on the exchange for just about six months! We all have different frames of reference for time. Each summer vacation used to seem like a lifetime when we were kids. Now, it feels like we’re picking up candy for trick-or-treaters an hour and a half after we got back from the beach on Memorial Day weekend. So how does one move away from the day traders view of time and towards an investors view of time? In investing, we discuss our investments in relation to our time-horizon. Time-horizons typically culminate in some sort of goal. Things like; a down payment for a house, tuition for our kids, a planned retirement date for ourselves. When I am developing a financial plan, I consider any goal within the next five years as a short time horizon and, as such, I need to ensure that the investments used to achieve those short-term goals are appropriate. Time horizons vary by goal but, like the endless summer vacations of our youth, the life of a day trader skews their understanding of time.
“I owe taxes?!”
Sure, you’ve paid taxes on the money that you’re using to invest, and sure, the companies that you’re investing in pay taxes as well, but Uncle Sam isn’t giving up his cut! The gains you receive aren’t completely yours to keep and the duration you’ve held the investment dictates how much you’ll pay. Quickly purchasing and exiting a position within one year that has appreciated generates a taxable amount referred to as short-term capital gains. Short-term capital gains are considered ordinary income, which is a fancy name for the tax rate you pay on your earned income. This can be far more than the tax rate you’ll be subject to should you sell a position after holding it for over one year. That is considered long-term capital gains and, as of now, those are capped at 15%. Obviously, paying taxes on an investment means you made money. That’s a good thing! What can be bad is not preparing for the tax liability those gains come with.
“What’s a balance sheet?”
Today’s Monster Energy Drink fueled day traders don’t bother themselves with silly things like company balance sheets and earnings calls. They’re too busy deciding which company to invest in by surfing Reddit and seeing which company is backed by the funniest memes. While I’ll concede that current valuations make it difficult to make an investment choice based on earnings or the company’s use of debt, it’s important to be methodical with our investing. We need to have a reason why we are making a specific investment and each investment should have a specific goal in mind. This brings us to…
“This is a great investment opportunity that I learned from Reddit”
While there have been some very intelligent posters that have put in a fair amount due diligence on the now infamous r/wallstreetbets forum, the VAST (and I truly can not stress that word enough) majority of posters in that forum have absolutely zero knowledge of investing. Listening to the advice of people that have pieced together their knowledge of financial markets and investing through memes can have a devastating impact on your portfolio. Surf the internet with caution and a high level of suspicion! While there is an element of “sticking it to the man” that I can understand, many of the people that piled into stocks like GameStop did so at share prices of nearly $400. Even after a surprise pop in GameStop’s share price this week, the traders that purchased at those all-time highs have experienced a nearly 70% drop over a couple of weeks. The question now becomes, who’s sticking it to who?
Really, there’s nothing inherently wrong with speculation. It’s an important piece of your overall portfolio. The trick is, to keep that piece from taking over your entire portfolio and mindset. Want some help decided how much you can allocate to speculative investments without losing your way? Reach out to us at Innova Wealth Partners and we’ll help you take some bigger swings without putting all of your goals at risk.
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