Why You Should NOT Invest in Meme Stocks (if You Value Your Money)

happy multiethnic women having fun while using gadgets in cafeteria

The crazy rise of GameStop, AMC, and Dogecoin left many of us thinking “what the heck?!” If you’re like me, you might’ve even (shamefully) felt a little bit of FOMO. “2000% gains in just a few months!!! If only I’d invested a little bit of money…” Known as “meme stocks” or “meme picks”, these companies have been all the rage in 2021. So I might be bursting your bubble a bit by saying that you should absolutely AVOID these stocks like the plague.

In today’s post, I’ll be going over why you should avoid investing in meme stocks. You’ll hear about not only my technical reasons but also my OWN experience investing in GameStop. Hopefully, by the end of this post, you’ll feel less left out the next time a meme stock goes on a run. Let’s dive right in!

What is a Meme Stock?

Before we about defining “meme stocks”, it might be helpful to start with defining what a “meme” is.

Google defines a meme as “a humorous image, video, piece of text, etc., that is copied (often with slight variations) and spread rapidly by internet users.”

Originally, memes were just pictures with text superimposed over them, but over the years “memes” have grown to be synonymous with any kind of inside joke which has become a large part of internet culture.

Why You Should Not Invest in Meme Stocks
Why You Should Not Invest in Meme Stocks

Memes are often associated with people of the ages 12-18, because whatever they find funny typically spreads around extremely quickly. Likewise, memes have gotten wackier and wackier as time has gone on because each generation is wackier than the last. Heck, I’m 18 and I don’t even understand some of the memes nowadays!

Stocks and Memes?

“What does this have to do with stocks?” Well again, memes started out as funny pictures but, with time, have spread to cover almost every industry. Finance included.

A meme stock is simply a stock that has no actual fundamentals or good profitability but is simply of interest because the internet deems it funny if it rises. Example:

“Hey you know that stock of the game company? Yeah that game company which is almost bankrupt and which Wall Street expects to fail? Wouldn’t it be funny if we got together a whole bunch of people and ALL bought the stock to send the price sky-high???”

People start to buy the stock, which causes the price to rise, which causes more people to notice and also makes the “inside joke” funnier, which causes more attention, which makes more people buy the stock… It’s a reinforcing cycle which can pump stock prices VERY VERY high.

If you still don’t quite know what meme stocks are, you can just think of them as “joke stocks” which have no true fundamentals but are being bought because people find it funny.

The Risks of Investing in Meme Stocks

Now, if you DO understand the meme stock cycle, you might be thinking to yourself, “hey that sounds great! If I can just catch the beginning of the meme stock popularity cycle and ride it to the top, I’ll make millions!”

True, you could, but you could also LOSE millions. Here are just some of the risks associated with meme stocks.

Absolutely No Fundamentals

Almost by definition, a meme stock will have terrible fundamentals.

After all, the whole point of a meme is for it to be funny. Now tell me which event is funnier:

a) Millions of retail investors cash out their bank accounts and put it into long-time performer and profitable investment fund Berkshire Hathaway

or

b) Millions of retail investors cash out their bank accounts and put it into an obscure almost bankrupt videogame company which NOBODY was interested in and which all of Wall Street was shorting

The more well-known and profitable a business is, the less likely it is to be a meme stock. It’s the more obscure and random stocks that fall into the meme stock category. (can you imagine Google, Facebook, Coca-Cola, or Apple being classified as a meme stock?)

By this logic, why would you ever want to invest in something with poor fundamentals? Warren Buffet once recommended thinking about buying stocks as buying the entire business. There’s no WAY you’d buy a business with terrible fundamentals, so why would you buy its stock?

If you answered “so I can sell once it peaks and make a quick profit”, you aren’t in the domain of investing anymore. You’ve entered the domain of trading. And statistics show that over 95% of FINANCE PROFESSIONALS can’t beat the market over the long run. The odds are certainly against you either way.

Volatility

This may not be a surprise to you, but anything lacking fundamentals will be very volatile. Just take a look at GameStop’s performance over the past few months.

Why You Should Not Invest in Meme Stocks
Why You Should Not Invest in Meme Stocks

This may not seem THAT crazy, until you realize that between January and March 2021, it’s gone as high as $400 and as low as $18.

Something that Morgan Housel mentioned in his book The Psychology of Money is that conviction plays a huge part your personal long-term financial performance. If you’re more convinced of a stock, you’re more likely to stick with it during the tough times and not sell.

One MAJOR factor that influences conviction is volatility. It’s not easy, even for the best fund managers, to hold on to a stock they see dropping like a rock one day and skyrocketing the next. Couple volatility with no inherent fundamentals to back it up, and you’re left with a stock which has ample reason to be sold at any sign of trouble. Selling low and buying high is, obviously, the OPPOSITE of what good stock investing should be.

All Hype

If you think you can tough out the volatility and also the lack of fundamentals, one final opponent awaits you: the fact that meme stocks are ALL hype.

With normal businesses, you can sort of gauge when to buy and sell. You buy when you feel like the business is undervalued relative to its fundamentals and when there’s growth potential. You sell when you feel like the business is overvalued and that there is no more growth potential (based on market conditions and your personal outlook on the future).

Meme stocks are different. Because of the lack of fundamentals, meme stocks only rise because of the hype surrounding them. People buy the stock because they think other people will jump on the bandwagon and start selling when they feel like other people will start selling. This makes it near IMPOSSIBLE to invest accurately.

Not only do you need to predict whether or not the hype surrounding a stock is going to continue (to buy the stock), you also need to predict whether the hype is going to die down soon (to predict when to sell the stock). Needless to say, these are tasks that even the best psychologists/influencers/traders have trouble doing.

And the cost of not doing so accurately could cost you your whole position.

Case Study: My Experience With Gamestop

I’ve been harping on why investing in meme stocks is a terrible idea this whole time, so it might be a bit ironic that I actually DID invest in Gamestop a while back. To be clear, I only bought one share, and it was with money that I didn’t need anytime soon. But still, looking back, I definitely should not have invested.

The breakdown of events goes something like this:

  • Jeff sees news about Gamestop
  • He ignores the news because he is a sensible investor
  • Then he sees more news about it and more social media exposure about Gamestop
  • Gamestop rises EVEN MORE and Jeff starts to feel antsy
  • Finally Jeff decides to buy 1 share “just for fun” at $360
  • Gamestop immediately plummets after Jeff’s purchase
  • Jeff gets scared of the plummet and sells the same day, netting a loss of -$150
  • Jeff takes the money remaining and tosses it into a SPY etf

Analyzing my own mistakes I can honestly say that I played right into all 3 risks that I listed above. I didn’t understand anything about Gamestop or its fundamentals (nor does it have any). The volatility scared me into selling (before it went back up again). And I couldn’t accurately predict whether a hype cycle had just started or was beginning to end.

Why You Shouldn’t Invest in Meme Stocks

Meme stocks have taken over the internet in 2021, but its important to note the risks before investing.

A meme stock, by definition is a risky stock which has no fundamentals (because otherwise it wouldn’t be funny). On top of that, they also experience tremendous amounts of volatility and are ALL based on hype. If you can stomach all that, then by all means, go crazy. But if not, I’d highly recommend considering other options for where to place your money.

That’s all I have for today. I hope you’ve gained something useful out of this post and leave feeling better informed about meme stocks and memes in general. Keep investing for the long term in things you understand and STAY AWAY from meme stocks. Happy wealth building!


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One Comment

  1. Good perspective Jeff! It’s hard to miss out on the crazy gains, but even harder to know which stocks will provide such crazy gains!

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