Scared of the greater fool theory
Question: I am sure that you have heard of the greater fool theory. Upon reading it, it led me to question whether stock market investing is still a good deal. I do not want to end up being the greater fool. What are your thoughts on this theory? Asked at “Ask a Friend, Ask Efren” free service at www.personalfinance.ph, SMS, Viber, Twitter, LinkedIn, WhatsApp, Instagram and Facebook
Answer: Quoting verbatim from Investopedia, “The greater fool theory argues that prices go up because people are able to sell overpriced securities to a ‘greater fool,’ whether or not they are overvalued. That is, of course, until there are no greater fools left. Investing, according to the greater fool theory, means ignoring valuations, earnings reports and all the other data. Ignoring the fundamentals is, of course, risky; and so people subscribing to the greater fool theory could be left holding the bag after a correction.”
Related to the greater fool theory is the advice that you should only invest money that you are willing to lose in the stock market.
Nobody, and I mean nobody wants to lose anything, more so money. The thing is, there is no investment in the world but one that is fully guaranteed against loss. Not even government securities are fully guaranteed against loss because there are inflation and price risks. It could happen that interest rates on government securities are below the inflation rate while the market price of the same securities can be below your cost if interest rates move up significantly.
So, if you invest only the money you are willing to lose, then you would not want to invest at all. And if you limit yourself to investments that cannot lose money for you, then you will not find any.
Investing only the money that you are willing to lose means that you are not really investing but are, in fact, gambling. And this brings me to the greater fool theory.
To be honest, you will really be a fool if, as Investopedia points out, you enter the stock market “ignoring valuations, earnings reports, and all the other data.” You will be the embodiment of the suicidal investor following the “Daw Theory.”
The Dow Theory states that a market is moving upwards if one of its indices advances above a previous important high and is followed by a similar advance in another index. On the other hand, the “Daw Theory” in Filipino states that, “Sabi daw maganda ’yung investment. (They said the investment was good.)” In other words, the “Daw” Theory is all about following unverified investing tips, most of which are offered for free.
So, how do you end up not being the greater fool when it comes to stock market investing? Here are five steps:
Know the returns you need to make and the risk you are willing to take. Get a financial planner to help you out with this one.
Determine if you are all SET to invest directly in the stock market. “S” stands for sizeable funds. “E” stands for expertise and experience in investing. And “T” stands for the time you are able to allocate to manage your money, which is typically full-time. If you are lacking in one of the S, E or T, just invest indirectly through pooled funds or investment management accounts.
Before investing, investigate the offer by doing your homework.
Diversify your portfolio to manage risks.
Monitor your performance periodically (but not necessarily daily especially if you are just investing indirectly).
Do the five and you will be a genius in investing in the stock market. Go ahead and invest in the stock market. But do it wisely.
And oh, by the way, that one investment in the world that is fully guaranteed is found in Luke 6:38. INQ
Efren Ll. Cruz is a Registered Financial Planner of RFP Philippines, seasoned investment adviser, bestselling author of personal finance books in the Philippines. Become a YAMAN Coach. For details, email [email protected]. To learn more about personal financial planning, attend the 90th RFP Program this June 2021. To inquire, e-mail [email protected] or text at 0917-.6248110
Copyright 2021 Efren Ll. Cruz, RFP. All rights reserved. This material may not be published, broadcast, rewritten or redistributed without the prior written consent of the author.
