Readers of this column are likely aware of some of the bizarre events transpiring in the equity markets today. Among them, stories of Reddit chatrooms driving short squeezes and massive single-day moves (in both directions) in companies with relatively weak fundamentals. If parts of the environment feel like the 1990’s dot-com bubble to you, I’m right there with you.

Some of the numbers are eyebrow-raising, to say the least: Morgan Stanley reported growth of approximately 900,000 new self-directed accounts in the second half of 2020; Charles Schwab (which is now combined with TD Ameritrade) has been routinely breaking records for daily client trades, processing some 8 million daily; the online trading platform, Robinhood, which targets millennials and younger investors, saw 500,000 downloads in December alone; a record 10 million new brokerage accounts were opened in 2020.1

Normally, I would support retail investors opening accounts and starting down a long-term path of saving and investing for the future, but not in this format. I’m concerned many of these investors are new to investing, and are trading on speculation, over-concentrating in ‘hot’ positions, and committing too much of their liquid net worth to short-term trading. I hope I’m wrong, but there is a long history of this type of enthusiasm/euphoria leading to major losses. History tells me that volatility and ‘heat chasing’ mints more losers than it does winners.

There is also growing evidence that retail investors are pushing even further out onto the risk curve by using leverage. Investors borrowed a record $722.1 billion on margin through November 2020, Charles Schwab reported a 16% increase in average margin loans balance in the last three months, and analysts at Piper Sandler noted that off-exchange trading – which captures the retail market – accounted for 48% of total trading in the first two weeks of January. Investor enthusiasm could be approaching a crescendo, which has historically given way to a reckoning of some kind.2

The more I see the stories build and engulf the financial media narrative, the more I am inclined to double-down my focus on quality and diversification. The temptation of triple-digit gains with just a few trades – and the ‘fear of missing out’ that many investors feel when they see get-rich-quick stories – often lures even the most disciplined investors to get in on the action. Doing so goes against just about everything I’ve ever learned about investing, however. When the market’s sirens are singing, it’s crucial to stick to the plan.

Most investors can get where they need to go over the long-term by owning a diversified portfolio of stocks (generally speaking, 30 – 60 stocks). Positioning a portfolio across sector, style, size, and country will almost always provide exposure to the best performing areas of the market while minimizing the impact of the weak performing areas of the market. Volatility gets smoothed out over time, and an investor can earn attractive, equity-like annualized returns. It doesn’t have to be more complicated than that, and investors don’t need a huge win in a single stock bet to get there, in my view. The journey to long-term wealth is also a lot less stressful, in my experience.

Bottom Line for Investors

In my view, some of the bizarre behavior we’re seeing in the market is a clear signal that investor enthusiasm is approaching a crescendo, which usually gives way to a correction of some kind to clear out some of the froth (and, unfortunately, wipe-out many over-risked and over-leveraged investors). My advice: avoid getting caught up in the swirl of rumors, chatrooms, sharp one day move, and hot stocks, and steady your investment ship to stay focused on a diversified portfolio of quality, earnings-generating companies. If you want to take some chances on some individual stocks or short-term trading, fine – but my advice is to never commit more than 10% of your liquid net worth to it.

Disclosure

1 Wall Street Journal. January 25, 2021. https://www.wsj.com/articles/small-investor-surge-shows-no-sign-of-slowing-11611574200

2 Wall Street Journal. December 27, 2020. https://www.wsj.com/articles/investors-double-down-on-stocks-pushing-margin-debt-to-record-11609077600?mod=djem10point

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