These Investors Are Making a Huge Mistake. Please Don’t Be One of Them.
This week’s edition of Money Talks will be a little different.
I’m not going to share a new idea on investing or personal finance as I usually do. Instead, I’m going to ask you for a favor.
Let me explain…
You’re probably familiar with the old maxim, “History doesn’t repeat, but it often rhymes.”
This saying refers to the general “cyclicality” of human behavior.
But it’s especially applicable to the financial markets, where the fundamental emotions of fear and greed have created a reliable pattern of “booms” and “busts” for centuries.
And unfortunately, I can’t help but notice that today’s market environment “sounds” an awful lot like a couple of notorious booms of the past.
First, there are some obvious similarities to the markets of the late 1960s and early 1970s. Back then, the “Nifty Fifty” was all the rage.
That was the name given to a group of 50 or so super-popular blue chip stocks at that time. The group included several companies that are still household names today, like Anheuser-Busch, the Coca-Cola Company, General Electric, IBM, Johnson & Johnson, McDonald’s, Procter & Gamble, and more.
This group was often described as “one-decision stocks,” meaning investors could simply decide to buy them and hold them forever without having to decide when to sell.
Unfortunately, that decision didn’t work out for most investors.
You see, while this group consisted of many fantastic businesses that are still thriving today, their popularity had pushed their valuations to sky-high levels. Price-to-earnings (P/E) ratios of 50 or more — more than three times the market’s historical average — were common.
When that “boom” inevitably turned to “bust,” many folks learned the hard way that a great business doesn’t necessarily make a great investment if you buy it at the wrong time.
Today, many investors have come to see tech stocks as “one-decision” investments as well.
Like the Nifty Fifty, most of these companies are incredible businesses. Yet, their popularity has pushed the prices of many of these stocks to nose-bleed valuations.
For example, a quick look at the top 15 holdings of the Nasdaq 100 Index — which account for more than 60% of the entire index by weight — shows many are even more expensive than the Nifty Fifty back then. This list includes:
- Tesla (TSLA) with a P/E of more than 550 (!)
- Nvidia (NVDA) with a P/E of 80
- Amazon (AZMN) with a P/E ratio of 61
- PayPal (PYPL) with a P/E of 59
- Netflix (NFLX) with a P/E of 59
- Broadcom (AVGO) with a P/E of 53
To be fair, some popular stocks like Apple (AAPL), Microsoft (MSFT), Alphabet (GOOGL), and Facebook (FB) currently sport less extreme P/Es in the high 20s or 30s.
Yet, those measures are still well above their long-term averages. And other reliable valuation metrics like the price-to-sales (P/S) ratio show even those stocks are pretty expensive today.
In short, investors who buy and hold these popular tech stocks today are likely to underperform the market in the years ahead.
That’s true even if the companies themselves continue to do well. And if any of them should run into trouble, the potential downside is enormous.
But the Nifty Fifty era isn’t the only period that rhymes with today’s market.
I also see some eerie similarities to the dot-com boom of the late 1990s.
Back then, investors went wild speculating on up-and-coming technology stocks.
They paid outrageous prices for companies that typically had no profits, no customers, and even no actual business to speak of.
We’re seeing a similar speculative boom in several areas of the market today.
Most notable is the recent frenzy around special purpose acquisition companies, or “SPACs.”
SPACs are also known as “blank check companies.” They’re essentially shell companies that raise money in a public offering to merge with a to-be-determined business in the future. And investors have been rushing to buy them like never before in history.
As foolish as the dot-com bubble was, the SPAC mania might be even worse. Even the most speculative dot-com stocks typically had a business plan and a potential (if far-fetched) path to profitability.
Many SPACs have neither.
Folks have also been piling into so-called “meme stocks,” like GameStop (GME) and AMC Entertainment (AMC), among others.
These stocks typically have actual businesses. Though, in the case of GME, AMC, and most others we’ve seen, they’re not particularly good ones.
But, like SPACs, it appears most people are buying these stocks with no regard for the underlying business at all. Instead, they’re buying because they like the stocks and believe they can act together to push prices higher.
We’re seeing a similar speculative frenzy in the crypto markets, where people are piling into cryptos like Dogecoin, which was created as a joke and has no actual use case. This behavior is pure gambling.
Now, as I told you when I launched this publication back in January, I’ve made just about every financial mistake in the book.
So, I know all too well how tempting it can be to join in on these booms. When you see friends or family members making easy money, it can be hard to resist.
But I also know just how badly these booms end for most of those involved. And this time around will not be an exception.
Sure, a lucky few might walk away with life-changing gains. But the majority of folks will end up losing every penny they gained and more.
I don’t want you to be one of them.
Fortunately, avoiding that fate isn’t difficult. In fact, just following the simple guidelines I’ve been sharing with Money Talks readers will go a long way toward protecting your hard-earned savings.
First and foremost, I urge you to stay conservative with most of your money. It’s not exciting, but it’s probably the most critical thing you can do to protect yourself.
Be sure to spread your investment risk across several different asset classes. Keep the bulk of your stock portfolio in high-quality companies purchased at reasonable prices. And hold enough cash to cover emergencies and sleep well at night.
Second, be sure to use proper position sizing on all of your investments.
As I explained last month, this just means investing more money in your lower-risk positions and less money in higher-risk positions. (If you’re a TradeSmith subscriber, our powerful Risk Rebalancer and Pure Quant tools will do this for you automatically.)
And, of course, be sure to have a clear exit strategy for every position you own. As regular Money Talks readers know, here at TradeSmith, we prefer trailing stop losses.
Our proprietary VQ-based trailing stops and Health Indicator trailing stops are the best we’ve found. But even a simple fixed-percentage trailing stop can save your portfolio from a devastating loss.
Notice I didn’t say you can’t or shouldn’t speculate on some of the riskier stocks I mentioned earlier.
That’s because it’s ultimately a personal decision. And frankly, I know some folks will speculate no matter how strongly I warn them against it.
In any case, if you follow these guidelines, I believe you can speculate without taking huge risks.
For example, I suspect a good percentage of readers probably own one or more of the popular tech stocks I mentioned earlier. And for a good reason…
As I mentioned earlier, they are generally fantastic businesses, and they’re some of the best-performing stocks in the market over the past few years. Despite their high valuations, they could continue to outperform the market — and become even more expensive — before this bull market finally ends.
(I should also mention that most of these stocks have been in the TradeSmith Health Indicator Green Zone for months or even years and remain “healthy” in our system today.)
So, there’s no reason you can’t own them today, as long as you follow the guidelines I just mentioned.
The same advice applies to the super-risky stocks I mentioned.
If you just can’t help yourself from speculating on a few SPACs or a meme stock, have at it. But you absolutely must keep your position sizes small and risk only money you can afford to lose.
If you stick to those guidelines, you should be just fine even if those positions fall 70%, 80%, 90%, or more (which is entirely possible). And if you get lucky, you might even walk away with some gains.
So, what was that “favor” I mentioned earlier?
It’s simple…
I’d like you to take a moment right now to send me a short note at [email protected], answering ONE of the following three questions:
- How are you currently following these guidelines in your portfolio?
- How are you going to follow these guidelines if you aren’t already?
- Why are you NOT going to follow these guidelines, and what will you do instead?
Why am I asking you to do this?
The most critical part of any risk-management plan is putting it into place before you need it.
And I know if you don’t take a little time to think about it now, there’s a good chance you’ll get busy, forget, or otherwise never get around to it until it’s too late.
So please, take a few seconds to send me a quick reply. There’s no need to share specifics unless you’d like to. And even a sentence or two is fine.
As always, I can’t personally respond to every letter, but I promise to read them all. I look forward to hearing from you.