Reckless Investing
Yimin Huang | June 3rd, 2022
Source: The Wall Street Journal
Investing has started to gain major traction among the public in recent years, with meme stocks grabbing the attention of internet surfers, and a general hype surrounding investing as a means to build wealth and achieve financial freedom. This is especially so during the COVID pandemic, where online brokerages have seen record increases in new accounts and trading activity as individual investors pile into the market in an attempt to seize on this year’s erratic stock swings (Wall Street Journal). For some, stock trading is seen as largely a game, a form of entertainment as an alternative to sports betting and casinos, which mostly halted operations amid global lockdowns. Furthermore, gamified platforms offering zero commission trading make investing easy and appealing, even addicting. It has also started to become mainstream, with traders sharing their gains and losses on social media, including the Reddit forum, Wall Street Bets, which has 1.3 million members (Vox).
Still, such platforms have become the embodiment of the democratization of finance, where participation is encouraged and financial opportunity is not just cordoned off for large institutions and the rich. Traditionally, each stock trading transaction comes with a fee, and big market-making firms like Citadel Securities and Virtu Financial pay millions of dollars to process the trades. Companies like Robinhood and major online brokers Charles Schwab, E-Trade Financial Corp, and TD Ameritrade Holding Corp have started offering commission-free trading and fractional shares, allowing people to invest with a smaller principal sum. This frictionless process by which people can make trades has helped boost retail trading.
However, not having a solid understanding of such financial instruments could lead to negative consequences. In 2020, a 20-year-old trader died by suicide after thinking that he had accumulated a massive loss of $700,000, though he had in fact misunderstood the financial statement, and admitted in a note that he had “no clue” what he was doing (CNBC). Such an incident may suggest the need for more safeguards for new traders.
While each individual has their own unique financial situation and perspectives on investing, there are a few key principles that can be useful in navigating the world of investing. Having a good understanding of your financial situation, including savings, credit card debt, student loan debt, emergency funds, etc., and figuring out your goals and risk tolerance is important before making any investment decision, especially since there is no guarantee that gains will be made from investments. Next, diversifying investments in different asset classes lower risks, and picking the right investments in each asset category allows for potential gains. The investment strategy of dollar-cost averaging, whereby one makes regular, consistent investments with a fixed sum over a period of time rather than a lump-sum contribution, also protects oneself from the risk of investing all of your money at the wrong time.
To be able to gain financial security over the years and enjoy the benefits of participating in the financial markets, it is important for individual investors to increase their understanding of the respective financial instruments and exercise caution and rationality.