How did you go bankrupt?Ernest Hemingway, The Sun Also Rises
Two ways. Gradually, then suddenly.
Winning the lottery sounds like a dream come true, until you understand most people who win end up broke a few years later. (Most don’t invest their money properly to make it last.)
Everyone knows the possibility of making a large sum of money fast is a thrill, especially if you end up turning a small amount of money into a heap of cash. Maybe that’s why Americans on average spend over $1,000 a year on lottery tickets?
Now, you’re probably thinking that investing, especially saving for retirement, is completely different from buying a lottery ticket. Here’s the problem: your brain doesn’t really understand the difference.
When you win, whether it’s a $100 scratch-off prize, a Texas hold ’em pot or a great trade in your brokerage account, your brain rewards you. This psychological process is identical to gambling addiction. And it’s potentially just as destructive. Especially when it comes to investing or saving for retirement, gambling is a dangerous way to think Here’s why…
The way addiction works is just brutal. As Scientific American explains, over time the euphoria of winning decreases. People tend to risk more and more to recapture that feeling. And when a big bet goes wrong, you can get crushed by losses. Like a steamroller smashing your wealth into dust. Worse still, some “chase the high” by leveraging their investments on margin (and we’ve seen how that ends).
Which brings up an important question…
What makes these fast profit opportunities so tempting?
“Look! A shiny quarter! And there’s another one!”
If you looked out on a road, and saw a bunch of quarters to pick up, that’s “free money.” So you would likely pick them up. The more quarters you pick up, the more money you would make.
Some investing fads can look like those free quarters, at first. The latest version of these quarters comes in the form of recent interest in the latest meme stock, AMC. Similar to the Game Stop fiasco, on Wednesday AMC stock price soared 100%, at times prompting a halt in trading.
As CNBC explained, the opportunity to pick up this quarter and put it in your pocket (or make a quick buck flipping today’s meme stock) was “irresistible.” CNBC went on to try and explain how to limit exposure and get out of the investment at the right time.
Yet quite a few investors likely took the AMC “meme stock” bait according to the same article:
Financial advisors often caution against getting caught up in such frenzies. Yet in a recent survey, 34% of advisors admitted their clients had bought GameStop, while 20% of them had purchased the stock themselves
Note that financial advisors, investing professionals who should’ve known better, played the meme stock game themselves!
The extremely volatile stock could skyrocket again, or fall even further next week. But the frenzy surrounding the AMC stock made a lot of people see it as a sure win, money in the bank, yet another shiny quarter to pick up off the road.
Wolf Richter pointed out the steamroller by quoting from AMC’s latest prospectus:
Under the circumstances, we caution you against investing in our Class A common stock, unless you are prepared to incur the risk of losing all or a substantial portion of your investment. [emphasis added]
How often does a company that’s issuing stock basically tell people not to buy it?
Richter says, “The decision makers in this deal are just ruthlessly taking advantage of people that are desperately eager to be ruthlessly taken advantage of.” These people so “desperately eager to be ruthlessly taken advantage of” are the people dashing into the street, waving their arms, begging for more quarters to be thrown their way.
They don’t see the steamroller.
The steamroller hasn’t gone away, either. Financial advisors know it’s there. Even AMC knows it’s there, and in the prospectus are shouting “Steamroller!” and pointing with one hand, while scattering more quarters in the street with the other.
It’s easy to lose sight of the bigger picture. It’s easy to forget there’s a steamroller headed your way when you’re focused on grabbing yet another of those shiny quarters, and one more, and just one more…
Gradually, then suddenly
The Hemingway quote pithily captures the tragedy of gambling addiction as played out countless times daily in the casinos of Vegas and Macau as well as the Robinhood “My Account” page.
The first time a bet goes bad, you don’t worry. You just have to bet a little more next time to make up for it. You just have to stay in the street a little bit longer, pick up just a few more quarters…
And when the bets get bigger, you spend more and more time grabbing those quarters. Surely there’ll be plenty of notice, surely you’ll hear the steamroller well before you’re really in danger. Right?
Perhaps it would be prudent to consider a different approach.
Maybe it’s better to stay out of the street
Bloomberg’s Matt Lavine has a different perspective on the financial steamroller:
A basic problem in finance is that it is just as good to avoid a $1 billion loss as it is to make a $1 billion gain, but the rewards are so asymmetric. If you make a $1 billion gain, everyone will notice, you will have a $1 billion P&L, you will be a hero and you’ll get a big bonus. If you avoid a $1 billion loss, no one will notice because there won’t be a $1 billion loss.
Saving for your future works the same way. The thrill of watching the pile of quarters stack up on your brokerage statement can be irresistible, even addictive. You might be lulled into believing your profits are stable, even guaranteed — after all, you’ve never actually been run over by the steamroller. Maybe, you might find yourself thinking, the whole steamroller thing is just a myth?
There’s only one way to find out (and it’s not something you can do twice).
Like Levine suggests, don’t be so focused on making a return that you neglect to avoid losses.
Start by examining your risk profile. Then consider diversifying your wealth across different asset types. Make sure you understand the advantages and disadvantages of each asset, especially how they respond when the steamroller arrives. Let the others scamper in the street while you look for nickels on the sidewalk
For Birch Gold Group’s Peter Reagan