Investing

Why hot stocks like Tesla and Virgin Galactic may not actually be wise investments

Tesla Inc CEO Elon Musk dances onstage during a delivery event for Tesla China-made Model 3 cars in Shanghai, China, January 7, 2020.
Aly Song | Reuters

If you've paid attention to the stock market recently, you've likely seen that Tesla stock is in high demand. So far this year, Tesla shares have more than doubled in value, rocketing from $424 to over $900 as of February 20.

And Tesla isn't alone. Spaceflight company Virgin Galactic is also blasting off, as the stock's price has tripled over the past three months.

Seeing stock prices surge in value during short periods of time can give some investors a serious case of FOMO. But it's also important to remember that these types of dramatic price jumps are often followed by declines. For example, already this month, Tesla stock tumbled 17% in one day while Virgin Galactic fell more than 8%.

News headlines may make it appear that you're missing out on big returns when stocks see huge growth over a short period of time. Keep in mind, though, that timing the market to maximize your return is almost impossible, even for professional traders. It's smartest not to try to pick winners, in other words.

That's why experts recommend that you let the market play out before making a decision to buy, rather than trying to chase a hot stock when it's surging. Or better yet, invest in the market itself, through index funds that track the performance of major market benchmarks. Investing a significant portion of your portfolio in individual stocks comes with considerable risk.

Betting on individual stocks is 'a dicey game'

Sure, Tesla's stock is soaring now, but plenty of people still expect the company will fail.

Some traders place bets that the stock will tumble, what's known as "shorts," and therefore stand to lose billions of dollars if share prices continue to rise. This dynamic is what makes the stock market especially risky when investing in individual companies: Nobody knows what's going to happen.

"It's a dicey game" for investors to try and pick winning stocks, says Scott Colbert, chief economist at Missouri-based Commerce Trust Company.

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Take Tesla, for example: "Tesla went public when it was nothing; there were no sales, it was all just [looking at] the future," Colbert says. "Now, they sold 367,000 cars last year. The people who bought in early had to ride a roller coaster. They had to stick with it for 12 years, but now it's paying off in spades."

Even so, it was a long wait for those investors to get to that payoff, and it was far from guaranteed. In fact, research shows that most investments in newly public companies lose money after five years.

How to hedge your bets

Because investing significant amounts of money in individual stocks — like Tesla or Virgin Galactic, or a market mainstay like Coca-Cola — is so risky, experts recommend that the typical investor instead look at more diversified products, like mutual funds or exchange-traded funds (ETFs).

If you're drawn to investing in space companies like Virgin Galactic, for instance, the Procure Space ETF could be of interest. It contains 32 aerospace and defense stocks, including Virgin Galactic, allowing investors to add the company to their portfolio while hedging some of the risks and getting exposure to the broader industry.

And for investors interested in Tesla, there are more than 100 ETFs that count the stock among their holdings.

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How the hottest IPO stocks of 2019 are faring now

Hot stocks have no guarantee of delivering big or even positive returns to investors. While a few have soared, like Beyond Meat, several high-profile companies that went public last year saw, such as Uber and Lyft, saw their stocks fizzle, or at least not live up to the hype.

Here's a look at how some of the most talked-about IPOs of 2019 look two months into 2020, based on their IPO price and the price as of the market open on the week of February 18.

SmileDirectClub

  • IPO price: $23
  • Total return since IPO: -42.3%

Lyft

  • IPO price: $72
  • Total return since IPO: -38.1%

Slack

  • IPO price: $42
  • Total return since IPO: -33.1%

Uber

  • IPO price: $42
  • Total return since IPO: -6%

Peloton

  • IPO price: $29
  • Total return since IPO: -5.2%

Pinterest

  • IPO price: $19
  • Total return since IPO: 22.1%

Chewy

  • IPO price: $22
  • Total return since IPO: 29.7%

Zoom

  • IPO price: $36
  • Total return since IPO: 259%

Beyond Meat

  • IPO price: $25
  • Total return since IPO: 472%

Though investing in them isn't always wise, tracking high-profile stocks may have an unexpected benefit. Seeing high-profile stocks' prices soar "can validate things for you," says Niv Persaud, a certified financial planner and managing director at Georgia-based Transition Planning & Guidance. "It shows you that it's a good idea to have money in the market."

That said, Persaud says you should stick to a predetermined investing strategy and not just try to pick the market's winners. "If you're a young or long-term investor, you need to focus on creating a diversified portfolio" before anything else, she says.

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All investments involve risk, including loss of principal. The contents presented herein are provided for general investment education and informational purposes only and do not constitute an offer to sell or a solicitation to buy any specific securities or engage in any particular investment strategy. Acorns is not engaged in rendering any tax, legal, or accounting advice. Please consult with a qualified professional for this type of advice.

Any references to past performance, regarding financial markets or otherwise, do not indicate or guarantee future results. Forward-looking statements, including without limitations investment outcomes and projections, are hypothetical and educational in nature. The results of any hypothetical projections can and may differ from actual investment results had the strategies been deployed in actual securities accounts. It is not possible to invest directly in an index.

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