News headlines have been saturated with the story of the rising GameStop stock. Nearly everywhere you turn, one media outlet or another is discussing how it happened and spreading conjecture about its potential long-term impacts.We felt it imperative to address our clients about this nation-wide stock frenzy and help put your mind at ease.
Our investing approach at Step by Step is built on a firm foundation, one that carefully assesses your risk preferences, time horizon, and goals. Day trading trends and get-rich-quick methods aren’t in our wheelhouse. It’s critical to understand these fundamental differences so you can find confidence in your investments and your financial plan at large. What happened with GameStop stock and will it affect your finances?
Let’s explore these ideas together.
The GameStop stock event
A Reddit thread called r/WallStreetBets played no small role in GameStops’ swelling share prices. The group discusses stocks and day trading options, and recently set their sights on GameStop.
GameStop is a brick and mortar chain dedicated to all things video games from consoles to accessories to titles and more. As with many businesses in the pandemic, profits plummeted in the last year. The trend toward digital gaming has also left GameStop in the lurch so to speak.
The company has certainly seen a change in its fortune due to the combination of the now-famous Reddit thread, individual investors, and, inadvertently, Wall Street hedge fund managers.
How did its stock price soar?
To unpack this question, let’s start with some context.
At this time last year GameStop stock traded for about $4 a share. At the start of 2021, its share rested at about $17. A week ago, it hit its highest numbers yet at $483 a share.
This startling increase is far outside a stock’s traditional volatility rate (even a significant one), so what happened? This is where a common (and dangerous) day trading trend comes into play—a short.
What is a “short?”
Before 2021, GameStop stock has remained relatively stable, yet Wall Street hedge fund managers thought that it was over-valued and shorted the stock in hopes of making money.
What does it mean to “short” a stock?
A short sale assumes the depreciation of a particular asset, in this case, GameStop. Investors borrow shares and sell them to later buy them back at a much lower cost and ultimately, profit from that mismatch.
GameStop has been a popular short for many professional investors until recently, of course, where the risks of this practice were highlighted and resulted in a short squeeze.
How a short-squeeze works.
Shorting a stock places all of your eggs in one basket. For this strategy to be effective (and yield profit), the stock must depreciate. In a short sale, investors borrow shares, meaning that one way or another, they are obligated to buy them back.
When a stock is over-shorted, like GameStop, a rise in price forces short-sellers to buy the stock back at a higher price than anticipated to cut their losses. Re-purchasing the stock at a higher price continually drives the cost up, resulting in significant losses, and a hefty per-share price tag, an unfortunate combination that Wall Street has had to deal with head-on.
This over-shorting buying frenzy set off a chain reaction of Wall Street vs the common investor and has been the source of media headlines and public scrutiny for the last couple of weeks.
What does all of this have to do with your investment strategy?
Active vs passive investing philosophies.
Investing isn’t one-size-fits-all; there are several schools of thought in the financial community. The two most common are active and passive investing. These theories differ in fundamental ways.
Active traders attempt to time the market, engaging in activities that help predict its movements and ultimately garner the largest profit.
But active investing doesn’t always yield high-rise worthy results. Many active fund managers are quite costly both in their personal fees and the fees incurred from several trades. Active investing has also been criticized for tax-inefficiency. Buying and selling stocks always come with tax implications, and more frequent activity often yields a much higher tax bill, eating into your net profits. In fact, it’s been discussed time and time again that active investing falls short of its passive counterpart.
Passive investing, on the other hand, takes a different approach. Many passive strategies seek to minimize buying and selling assets (making it more tax-efficient, a practice we whole-heartedly believe in) and often track a market-weighted index or portfolio like the S&P 500.
Passive investing requires a long-term approach, one crafted to suit your risk tolerance and capacity, time-horizon, as well as your goals. Curating a portfolio with diligence, strategy, and care is best suited to helping you reach your financial goals.
With long-term passive investing, you don’t have to lose sleep over shorted stocks or day trading trends because your portfolio isn’t built for the short-term, it’s built for the long-term.
Why Step by Step believes in passive investing.
As a CFP® professional, we dedicate ourselves to helping you reach your financial goals in fulfilling, enriching, and ethical ways. Our team follows the CFP Board’s 7-step financial planning process that best illuminates your needs, wants, and goals, and gives us the tools to help you get there.
Passive investing is far from idle—it’s comprehensive, holistic, and honest. Investing always comes with risk, but our philosophy helps you better understand that risk and build a portfolio that best represents where you are and where you want to go.
Investing for you and your family’s future is a personal experience, one that should thoughtfully consider all the moving pieces, not rely on timing the market.
We’re here to help bring purpose and value to your financial life.
The GameStop stock event has sparked much conversation in both professional and personal circles. Investing should be more than the product of day trades gone wrong, it should be about the cultivation of your goals, dreams, and vision for the future.
If you’d like to talk more about your investment plan or if you have any questions about our investment philosophy, don’t hesitate to reach out. We’d love to speak with you.