Millions of people are jumping into the stock market. We’re here for it. It seems easy. It can be fun. Isn’t it for everyone? Plus, you never know when you could take a little play money, trade a hot stock, and double it up.
But your real money? That long-term, easy-living, retire-where-and-when-you-want money? That’s our forte. Buying into the entire market, setting goals, saving easy—that’s investing for better. It won’t make you a millionaire overnight. But it could probably help make you a millionaire over your lifetime.
We asked Dan Egan, VP of Behavioral Finance & Investing at Betterment, to comment on the longer term effects of entertainment investing and how to know if it’s right for you.
What happened with Gamestop? What are the broader trends at play here?
Dan: The rally and collapse in GameStop hit basically all the classic notes of a bubble and burst, with some added intrigue around short squeezes.
To understand the specifics of what occurred, start with this article from The New York Times: “4 Things to Know About the GameStop Insanity.”
If you’re interested in exploring some of the psychological aspects behind investor behavior, I touch on that in “Memestonks: What’s Different About This Market?”
What is “entertainment investing” and how is it likely to evolve in the future?
Dan: It’s investing to entertain yourself, to get stimulated or excited, to relieve boredom. It’s not about long-term growth in the economy, or discounted free cash flow. It’s about being in on the hot new stock, or seeing huge movement in your accounts, and being able to talk about it with other people.
There’s a reason BarStool Sports founder Dave Portnoy got into day-trading: the excitement of winning and losing, the ability to yell at the refs and regulators, the game we can all access and play regardless of how small. And finally, don’t forget: the thrill of making and losing money.
How does the internet and social media change investing?
Dan: It speeds everything up, usually not in good ways.
Stock markets already operate at the millisecond. Professionals have news parsed, analyzed, and acted upon by algorithms faster than any human.
Social media and always-on news means you hear news faster than ever before, and with greater variety in what you hear. Conspiracy theories and misinformation spreads faster than boring truths. Once you’ve shown interest in a stock, your Facebook, Twitter, Youtube, and TikTok accounts will all double down on that content, hoping to keep you for a few more seconds, a few more ads. This reduces the diversity of perspectives you see.
Thus, social media encourages large, dispersed groups of people to coordinate on a single stock or issue, giving it the feel of a grassroots movement. This means that high prices and short-term volatility are more likely to occur, especially in companies consumers interact with.
These dynamics have always been at play in markets—that’s not new. Now we’ve sped them up through the internet and fractured social networks.
How is the investing industry changing?
Dan: Over the past 40 years there’s a consistent trend towards consumers paying less and less for trades, investment management, etc. That trend recently crossed a tipping point, with some consumers paying $0 for trade commissions, $0 for investment management, or $0 for advice.
Most folks love free, so companies that offer free trading have grown dramatically in recent history.
Of course, those companies are still getting paid, just not directly from the general investor.
Free trading services often make money by sending your trades to people who pay to trade against you. These are high-frequency trading shops, hedge funds, etc. When you sell a share for $99.96 and a buyer pays $100.00, these brokerages get the $0.04. This is called the ‘spread’. Do that billions of times, and you can see how they make money.
So, they want users to trade a lot. They want users to trade in stocks with bigger spreads. And they don’t care if users make or lose money—they win as long as users trade. Users are the gravy.
So it still costs you, but you can’t see how much. You can easily compare trade fees, but not the spread you pay.
It is easier than ever to invest well: the minimums are low, the costs are low, diversification is easy, and the markets are reasonably well regulated.
It’s also easier than ever to invest badly: you can access leverage, derivatives, and leverage to buy speculative, concentrated assets you don’t really have any underlying understanding of.
How will these recent trends in investing impact long term investors?
Dan: For the most part, positively. Gaining exposure to genuine economic growth is easier than ever. Holding a broad-based, diversified portfolio means when a new company gains ground, you were already invested in it.
That’s part of why Betterment invests beyond the S&P 500: a diversified portfolio with a mixture of stocks and bonds and international exposure helps mitigate risk.
Has anything like this happened before, and what has been the impact?
Dan: Yes, bubbles—and bubbles popping—happen all the time.
They all have a slightly different flavor: 2001 was the original tech/internet bubble popping, 2008 was based on leverage in the housing market, etc.
The biggest difference between any two stock-market cycles is whether or not it impacts the real economy, generally through de-leveraging. The stock market can crash without an impact on the real-world economy because all assets are just valued lower. But when that lower valuation causes deleveraging and bankruptcies, the real-world is impacted and it’s dramatically worse.
Should I start investing in individual stocks too? How do I know if it’s right for me?
Dan: That depends on if you want to. You don’t have to if you don’t want to.
I think of it much like this: I could bake my own bread, change the oil in my car, and build my own custom closet shelves. But should I? Here are questions I ask myself whenever I’m tempted to D-I-Y:
- Do I really want to do this? Will I enjoy it? Will it reduce my time doing other things I enjoy more?
- How much more will it cost me if I do it wrong, or to a lower quality? Will I need to pay for tools that professionals already have?
- If I want to do it to learn, that’s great. I’ll need to be deliberate about learning, which means setting up high-fidelity feedback loops about successes and failures. Am I ready to recognize and learn from failure?
- Am I ready and willing to fire myself if I’m not good at it?
It’s fine to have a hobby, but with most hobbies we don’t harbor a belief we might get rich quickly with them—we do them because we enjoy them. Make sure you’re enjoying yourself in the process.
How can services like Betterment compliment an active trading strategy?
Dan: It’s important to remember that you don’t have to choose between being a long-term investor or an active trader. Long-term investing can be a great compliment to a trading strategy, especially if you want to meet your financial goals like retirement, saving for a home, or saving for college. Betterment helps you invest in what matters to you by helping you define your goals, recommending how much you should save, and tailoring your portfolio recommendations based on when you need the money.
For those who do want to actively trade, you can set up a “get rich” portfolio and a “stay rich” portfolio. For example, you can open a riskier “get rich” portfolio at a broker that allows you to day-trade stocks and crypto, then set up a long-term “stay rich” portfolio with Betterment. This way, you can day-trade guilt free without compromising your financial goals.
To start, you can allocate about 10% to 20% of your wealth to your “get rich” portfolio, and the remainder to the “stay rich” portfolio.
If or when your “get rich” allocations grow to be 40% of your overall wealth, rebalance it back down to 10% to 20%.
If you’re lucky, you might still get rich and stay rich.
If you’re not, then the best case scenario is that you still have your long-term investing and savings squared away for future use and you don’t have to start saving all over again.