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2021 has been pretty exciting for stock market news, and that’s not always a good thing. Nobody ever writes the headline ‘Passive index investors continue to perform extremely well over the decades’, as it doesn’t grab enough clicks or eyeballs. So instead, we get news about GameStop and Bitcoin. 99.99% of the financial news should not change how you invest.
Read it out of interest for what’s going on in the world, but don’t let it change your investment approach.
Just don’t. It’s a slippery slope that leads to shiny object syndrome, FOMO and market timing, all of which will part you from your money.
Let’s have a look at a couple of newsworthy events and see if they merit a reaction.
Gamestop – what the hell happened
Gamestop is a struggling retailer of video games. Lots of hedge funds were shorting it, i.e. betting its share price would go down by borrowing its stock for a limited period of time, selling it and then hoping to buy it back cheaper, locking in a profit. This is great if the price actually goes down, and painfully awful if the stock goes up. Don’t try it at home.
Some individual investors on the Reddit meme-investing board WallStreetBets realised the stock was oversold and encouraged lots of people to buy the stock, pushing the price up. This would force the hedge funds to buy Gamestop at a higher price or risk huge losses. As the price goes higher, the shorters would be ever more desperate to get out at any price – this is a ‘short squeeze’.
So lots of people piled in and the price went up from $20 on 12 Jan to $396 on 28 Jan. Some people made millions. It was all over the news and we all got FOMO. What would happen over the weekend? Well on Monday 1 Feb, Robinhood, Interactive Brokers and plenty of other brokers blocked people from buying more GameStop shares and some others that had shot up. You could still sell though.
People were upset. Robinhood, the broker app that had gamified trading and promised to be on the side of the little guy, suddenly seemed not to be. Were they just puppets of the hedge funds, dark lords and deep state after all? Was the stock market about to collapse and take our money with it? Should we run away from Interactive Brokers?
What we should do about it
When most people can sell but not buy a stock, the price goes down. GameStop is now at $50 and falling fast each day. If you FOMO’d into the stock at $396 or even worse bought an option (let’s not go there), you would have lost a lot of money. People who bought at $20 and are holding still are only looking at a 2.5x gain.
So there has been a lot of heat and a lot of noise and then… back to business as usual. It’s all very predictable. Yes, with lots more retail investors out there, we can expect more volatility and unexpected surges/collapses in individual share prices. But we’re not in the business of investing individual stocks, are we? We hold global funds with 3500+ stocks in them and we hold them for decades. So none of this impacts our investing.
Lesson 1: Any dabbling in individual stocks is strictly fun money only, i.e. max 10% of your investment portfolio across allll individual stocks, stocks from your employer, active funds, sector funds, FX trades, crypto, commodities except gold, options, peer-to-peer lending and startup investments. Because all these things can crash hard and damage your retirement portfolio permanently.
By the way, that’s 10% of your portfolio size, but it’s not in your portfolio. You have to add it on top. Your portfolio needs to be boring and sensible (a global stock fund and a global government bond fund).
For all the conspiracy theorists outraged by Robinhood’s antics and betrayal of the freedom fighters, it’s pretty clear what happened. On Monday morning, they were woken up by a demand for a $3 billion security deposit from the DTCC, which manages the archaic back end of stock markets. They make sure a buyer and their money from one broker is matched properly with a seller and their stock from another broker. This clearing and settlement process happens over two days for stocks, and if a broker goes bust in that time, the other broker can be left to pick up the bill.
$3 billion is more than Robinhood had as capital for its whole business. And no matter how much it loves the individual trader, a run in with its clearing house and/or the regulators could close it down. So Robinhood haggled – a $700 million security deposit if they stopped people opening new positions (i.e. buying) in certain stocks like Gamestop.
Should we be worried? I don’t think so. A new market vulnerability appeared, as it does every so often, and was shut down in a pretty standard way – if you as a broker want to keep making the problem worse, the protectors of the market are going to ask you for billions as security to offset that risk. So the brokers stop making the problem worse. It’s self-healing without massive regulatory intervention. Joe Biden did not have to step in.
Robinhood may suffer but then I don’t recommend buying your long-term investments through them anyway. Interactive Brokers may lose a few customers and have some attempted revenge hacks as a worse-case scenario. But they have millions of customers who don’t care about GameStop and they face hacking attempts every day like any online company.
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a) Secure your account. Ensure two-factor authentication is in place, so nobody can hack your account without your face or finger on your phone.
b) Download statements every month or quarter so it’s clear what funds you own, the price you paid for them and their current value.
c) If you’re with Interactive Brokers, I would suggest not holding more than the SIPC protection level (stocks & ETFs: $500k for individuals, $1 million for joint accounts). I’m not too bothered if your account grows a bit beyond these levels, but I would use a second brokerage company to add money beyond this.
These steps serve to protect you against worst-case scenarios where unexpected events damage your broker. But these occurrences are very unlikely. The GameStop saga is just a good reminder to put these safety nets in place and rein in any FOMO weaknesses you have. If this seems scary or confusing, maybe you should join my Expat Investing Academy and learn how to manage your own money in a sensible and transformative way that will take you just a few hours per year.
Next time I’ll talk about Bitcoin and whether that should change our investing approach. If you have any comments or questions about what I’ve have discussed here, add them below!
Image: Invader – one of my favourite street artists, with mosaics all around the world. Download a map of them in your favourite city or just keep a look out as you walk around. RIP the ones in Neal Street, London 🙁
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