Investing

GameStop mania, 1 year later: Investors who ignore meme stock risks may 'pay the price,' says Columbia prof

"If we treat the stock market like a casino where we try to flip assets quickly for a profit, it just won't last forever."

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A GameStop location in New York, Dec. 23, 2021.
Scott Mlyn | CNBC

This week marks the one-year anniversary of "meme stock" mania. Over the past 12 months, stocks favored by traders on social media, such as GameStop and AMC Entertainment, have been to the moon — and back.

It's been an eventful journey. After GameStop shares had hovered under $5 for much of 2020, traders on social media forums such as Reddit's "Wall Street Bets" page saw an opportunity in early 2021. By piling en masse into the stock, traders forced what's known as a "short squeeze" — a scenario in which short-sellers, many of them hedge funds in this case, are forced to start buying shares to mitigate their losses.

Prices skyrocketed, but not for long.

On Saturday, it will have been a full year since GameStop shot to $325 per share. From there, it cratered to $41 in February, and then ping-ponged around for the rest of the year.

Many other meme stocks followed a similar pattern. On a calendar year basis, GameStop in particular did great, returning an eye-watering 688% in 2021. Depending on when you bought in, though, you may have fared substantially worse. GameStop shares had shed 37% as of market close on January 27 and AMC shares were down 47%.

That doesn't mean that the meme stock craze is over, but it may be time for investors to face the realities of holding speculative assets, says Joshua Mitts, an associate professor at Columbia Law School specializing in securities law.

"If we treat the stock market like a casino where we try to flip assets quickly for a profit, it just won't last forever," he says. "Time after time, speculative bubbles have popped when they ran out of buyers. It happened with Dutch tulips; it happened in the subprime housing bubble of 2007; and it's still true."

He adds: "Anyone who thinks they're exempt will pay the price."

Market conditions have gotten worse for meme stocks

While much of the early narrative around meme stocks centered on a group of social media-based traders banding together to stick it to the institutional investing crowd, it was extraordinary market conditions that made those trades possible, says Jay Hatfield, chief investment officer at Infrastructure Capital Management.

By early 2021, the stock market had rebounded from its early pandemic drop — thanks to stimulus money, low interest rates, and bored investors stuck at home. Once again the major indexes notched new record close after record close.

The result was a market in which investors, especially new ones, came to believe that stocks, regardless of their underlying fundamentals, always go up. "Meme stocks, crypto tokens, and SPACs all rose to valuation levels that made absolutely no sense," says Hatfield.

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With the Fed expected to shift course in 2022 and move away from policies meant to stimulate a pandemic-crippled economy, investors are rapidly moving out of riskier assets. That move has caused a downdraft in the stock market and an even more marked decline in meme stocks.

"When the macro environment shifts like this, it becomes harder to justify the idea that stocks are always going up," says Mitts. "People become more hesitant and more risk-averse. It's happening in crypto and a variety of other speculative markets, and meme stocks are one iteration of speculative markets."

The difference between investing and speculating

If there is one thing that investing experts like about the meme-stock craze, it's that it drove a massive influx of new traders into the market.

The sooner you begin saving for long-term goals such as retirement, the thinking goes, the better. That's because maximizing your time in the market theoretically gives your portfolio the best possible chance to capitalize on the long-term power of compounding growth.

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But 35% of investors who entered the market for the first time in 2021 still holds at least one meme stock, according to a survey from Investing.com. Those investors could be making two big mistakes, which negate the reasoning behind long-term investing, experts say.  

  1. They're focusing on individual stocks. The long-term benefits of compounding returns work under the historical assumption that the broad stock market tends to increase in value over the long term. Buying a broad swath of the stock market gives you the best chance of harnessing this steady growth rather than being overly reliant on one or two stocks which could grow or potentially fall in value.
  2. They're ignoring fundamentals. Typically, movements in a stock's price are driven by changes in the firm's underlying fundamentals, such as growth in earnings, sales, or cash flow. "Many new investors don't care about fundamentals," says Jesse Cohen, senior analyst at Investing.com. "They'd rather invest in a stock trending on TikTok, Reddit, Discord, or wherever else they get their financial news."

    Assets that aren't driven by fundamentals move purely based on investor sentiment, making them prone to volatile swings that could cripple your returns if things go the wrong way.

    Plus, buying an asset solely because you think it will move up or down in the short term is a form of trying to time the market, an nigh-impossible task, even for professional investors.

How to incorporate riskier bets into your investments

That's not to say there is no room for individual stocks or even speculative assets in your portfolio. But you'd be foolish to make them the main building blocks of your long-term investment plan, experts say.

Carve out a small chunk of your assets that you'd be willing to lose, suggest Charles Rotblut, vice president of the American Association of Individual Investors. "These are the kinds of stocks you'd look at with the money you might set aside for gambling," he says.

"Maybe you have a small portion of your portfolio you'd be willing to take a big loss on, that if you wipe it out, it won't affect your goals," he adds.

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Hatfield suggests focusing on stocks trading cheaply compared to their earnings and that throw off high amounts of cash in the form of dividends. No meme stocks fit that bill, he says.

"If you give me $100 and I give you $5 every year for the rest of your life, you probably take that deal," he says, comparing the scenario to investing in a high-quality dividend stock.

But "if you give me $100 and I tell you I won't give you anything and it might go up or down, nothing is certain," he says. "You can make money doing that, but it's just like going to the roulette table and putting everything on black."