“Crashes are not randomly occurring lightning bolts; they are the consequence of the madness of crowds who are busy avoiding the last mania as they participate in what will turn out to be the current one.”
Emanuel Derman
In last month’s post, I discussed crypto currency and non-fungible tokens (NFTs.) I perceive these as the latest investment craze being pushed by mostly non-professional social media “influencers.”
For me, these asset classes - if they can be called that - almost certainly represent a dangerous financial bubble that most investors should consider avoiding. A few days ago, this headline appeared in the Wall Street Journal:
Jack Dorsey Tweet NFT Once Sold for $2.9 Million, Now Might Fetch Under $14,000
Modest bids for tweet, converted to a nonfungible token last year, show a maturing NFT market
That would be a loss of about 99.5%. If you read last month’s post, then you know this does not bode well for the owner of the Pop-Tart Cat.
Anyway, humans are social beings and following the crowd can be a blessing or a curse. What I want to concentrate on is a specific way in which following the crowd is a terrible idea and can have long-term consequences of a type most people do not consider.
To refresh your memory, here is the example we used last month:
If we are walking down the street and suddenly everyone begins running past us in terror, we often will run along with them. Even if we never see what they are running from.
If it is a false alarm, we figure the worst that can happen is that we break a sweat. We feel that by following the crowd, no real harm will be done. For this example, I mostly agree.
If we follow the crowd into some investment craze, we might think in a similar way. “What’s the worst that could happen” or “Nothing ventured, nothing gained,” we tell ourselves. All the while fully expecting to gain a handsome return on our money.
I have observed that when people lose money, especially if it happens more than once and/or the loss is significant, they can lose something far more valuable than the money they invested. They can lose confidence in investing.
When we continually get bad results, in any endeavor, it is difficult to not feel a little snake-bit. That is, the feeling that everything we do will go wrong. That we will be “damned if we do and dammed if we don’t.”
With regard to investing, however, this has simply not been historically true. Over time, the people who have been invested the longest tend to have the best results. Intellectually, most people understand this, which is why they invest in the first place.
When we feel the sting of loss, however, it is natural to pull back and become defensive. Instead of taking the long view of effective portfolio construction we sometimes adopt a mindset that emphasizes avoiding pain over the prospect of long-term gain.
People who fear loss often will keep their money in cash. Do not mistake what I am saying. There certainly are reasons to have or maintain a large cash position, relative to your total assets. Perhaps you are buying a home, investing in a business, or are evaluating investment options, to name but a few things.
What I am referring to are large cash positions that are maintained and even increased over many months, years, and decades. Why is cash a poor long-term choice? I will let Warren Buffet, the most successful investor of all time, answer this one:
Today, people who hold cash feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to lose value over time.
In today’s inflationary environment, it seems like the cost of everything is going up almost daily. As prices rise our dollars buy less. Though your bank balance does not show it, cash is losing value more quickly today than at any point in 40 years.
Most people do not invest for the fun of it or because they cannot resist the riveting allure of balance sheets, 90 day moving averages, and income statements. They invest because they want the money they worked hard to earn, working hard for them in return.
The risk of following the crowd into the most recent investment craze can be far greater than the dollars at stake today. It can cost us now, in the form of lost dollars, but also in the future, in terms of dollars we never make because we become reluctant to lose.
Over a lifetime of investing there are going to be pullbacks, rough patches, and outright losses. This is true for everyone who has ever invested for any length of time. Never doubt it or allow yourself to believe you are exempt. It comes with the territory, as they say.
On the flip side, constructing and remaining committed to a well-diversified financial plan can round out the edges of volatility, make the wealth building ride less bumpy, and take some of the sting out of those inevitable losses. By diversifying within and among assets classes, we can maximize the likelihood that there will be components of your portfolio that are working as designed and that our assets will grow over time.
When it comes to our finances, we have the power to live by default or design. If we choose default, by definition, we are not following a clear and consistent plan. Therefore, we are far more open to becoming swept up in the latest investment mania.
When we live by design, we need only stick to the plan we have implemented. A sound and unified plan can apportion a certain amount of savings for speculative investments. In this way, we can work toward achieving a Goldilocks scenario in which the financial planning porridge is neither too hot, nor too cold, but just right for you.
There are times in life when following the crowd is perfectly sensible and others when it is perfectly bonkers. If you are looking for the beach and decide to follow a bunch of families wearing bathing suits and flip-flops - sensible. Following a Twitter mob into the latest investment craze - bonkers. In my humble opinion, at least.
If you see the wisdom of avoiding the madness of crowds and living your financial life by design, consider speaking with a financial planner who has earned your trust to help build a plan that is right for you.
Scott R. McGimpsey April 29th, 2022
This blog post was written by Scott McGimpsey and does not necessarily represent the views of Cetera Advisor Networks LLC. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. Neither Cetera Advisor Networks LLC nor Scott McGimpsey is engaged in rendering legal, accounting, or other professionally services. If such assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any federal, state, or municipal tax penalty. Moreover, a diversified portfolio does not assure a profit or assure protection against loss in a declining market. Cryptocurrencies, Digital Assets and other Blockchain related technology (such as Bitcoin, Ethereum, NFTs and others) are not securities, not regulated and not approved products offered by Cetera Advisor Networks LLC, and cryptocurrency or other blockchain related non-securities products cannot be recommended, offered, or held by the firm.