Questions help investors still the slippery siren's call of investment bubbles
Financial planner Shawn Lantz of Edmonton says he knew the marijuana industry hype was getting out of hand when he got a call from an elderly client recently.
"She's a 68-year-old grandma ... She phones me up and says, 'Shawn, my kids bought this weed stock and it's making lots of money. Should I buy some, too?"'
He asked what she knew about the company, had she looked it up on the internet, was it profitable and, if not, could she afford to wait until it was making money to recover her funds? She confessed she hadn't done any of that and reluctantly agreed to sleep on it.
"She phoned me up the following day because that stock went down about 20 per cent," Lantz said.
"She said, 'I don't care how much money that stock would have made, I just couldn't handle that kind of up-and-down in my portfolio."'
Financial experts say managing their clients' expectations is getting increasingly complicated as interest in the cannabis industry surges ahead of legalization in Canada, despite fear that the sector is either already in or headed for "bubble" status — overinflated by investor enthusiasm to the point where value explodes with a mighty "pop!"
Meanwhile, wild gains (and losses) in the value of cryptocurrencies are also prompting plenty of inquiries from investors — steep swings that some market-watchers attribute to automated trading systems programmed to buy and sell based on several variables.
Bubbles often rise when money is cheap — in December, a Natixis Investment Managers' survey of 2018 expectations found that 77 per cent of managers of big investment funds fear low global interest rates have created asset bubbles in sectors around the world.
Throughout history, experts have observed that people are far from logical when investing their own money, said Amos Nadler, assistant finance professor with the Ivey Business School at Western University in London, Ont., adding behavioural research he's doing today confirms nothing has really changed.
Bubbles from the past include the Dutch tulip bulb crash of 1637 and the dot.com tech stock meltdown in 2000 when millions of dollars was invested in new internet companies, many of which later collapsed.
"The way humans evolved has not optimized us for the environment we're currently in and that's what makes us vulnerable," Nadler said, describing people's "herding" tendencies.
Investors have an innate ability to talk themselves into making an investment even when they know they shouldn't. They see others boasting about big profits and "regret aversion" kicks in.
Nadler cited an investing research project where subjects were given an imaginary stock and asked to trade it. The value almost always rose into bubble territory despite the investors being told exactly what its future value will be.
Men are much worse than women in bidding an investment beyond its real value, he said. Results published last year from a research project Nadler worked on showed that administering testosterone to male investors made the resulting investment bubbles even larger and longer lasting.
Investors who recently made a gamble that paid off will remember that bet much more clearly than the previous several bets that failed, he added.
Some investors will buy an investment knowing that it costs too much because they think they can sell it before it reaches its peak, although studies suggest it's almost impossible to predict when a bubble will pop.
Self-discipline is needed to avoid following the other lemmings off the cliff, Nadler said.
"You can go ahead and buy cryptocurrency or weed stocks or whatever you want, but ask yourself, 'Am I investing or speculating?"' he said.
He said good investors are humble. They ask themselves if they are really smarter than the person on the other side of a trade, who could be a professional trader with a staff of researchers or an industry insider who knows exactly what each investment is worth.
Lantz, meanwhile, said he doesn't tell clients they can't invest in speculative stocks but he tries to help ensure they understand the risks.
If they still want to invest, he will help them do it — but he won't make recommendations.
He said he doesn't want to be liable when those bubbles burst.