Technology stocks have been all the rage the past few years. Investors in technology companies like Nvidia, Microsoft and Alphabet (Google) have seen big gains. You might be wondering if you’ve missed out and whether you too should have gone all-in on trends like artificial intelligence, social media and electric vehicles.
Although the returns have been good, the risk of investing in a concentrated number of hot companies is not for the faint of heart. They can be very volatile. That's because popular stocks like these usually attract a lot of investors, many of whom are regular folks without professional investment experience who are vulnerable to herd mentality. This can lead to a frenzy that drives a stock price up - and up and up. Rationally, a stock’s price should reflect its business prospects and investors should carefully look at the company’s earnings and its prospects and decide what to pay for the stock. When stocks get hyped up though, all of this goes out the window. The internet has magnified this problem, as platforms like Reddit and TikTok are megaphones for trumpeting the praises of a particular stock. As investors hear the hype and see the stock go up, they pile in, sending it even higher. In these situations, the price of the stock becomes totally disconnected from the value of the company.
This price disconnection means trouble – sometimes big trouble. Because the stock price is so high, expectations of the company are also high. Any bit of bad news related to the company or the company’s industry can send the stock tumbling. As the stock starts to lose value, the opposite of the prior euphoria kicks in and people start selling, driving the stock down even further.
This summer, we’ve seen this in action. In July, US technology stocks tumbled: over a two-week period ending July 24 Nvidia fell 15%, Meta (Facebook) declined by 12%, and Tesla (not a tech stock but acts like one) was down 19%. Keep in mind that the long-term return of the US stock market is about 8.5% per year on average – so a 15% decline is big. Meanwhile, the S&P 500 was down a more modest 4%. Why did these big tech names tumble? Because their earnings aren’t living up to the hype. For example, Alphabet (the parent company of Google) fell 5% on Wednesday; even though their earnings report was better than expected, the numbers just weren’t good enough, a sure sign that the stock is priced higher than is rational.
Over the past couple of years, I’ve met clients whose portfolio has a lot of technology stocks in it. Some of these people have made a lot of money. The truth is that there’s a lot of luck involved. It’s true that some people were ahead of the curve on trends like AI and electric vehicles – and therefore got into Nvidia and Tesla early on – but replicating this success a second time is nearly impossible. And it might not have gone so well – there are many stocks that seemed to have bright futures that went absolutely nowhere or worse, went down to become penny stocks. No one brags about those stock picks. In my 15 years working as an equity analyst on Bay Street, I saw many companies that were trumpeted as the next big thing by professional stock analysts but it turned out that most of them were not the next big thing at all.
The message is simple: stop worrying about the one that got away, don’t listen to the chatter, and do not blindly follow the advice of social media influencers. Instead, stick to the basics. Own a lot of stocks in a lot of markets, don’t make judgement calls, and buy and hold for the long term. This means owning a handful of exchange-traded funds that track the broad market indexes like the S&P 500, the S&P/TSX Composite Index and international indices like a Europe, Asia and Far East (EAFE) index. And don’t worry – you’ll still get the tech stocks. When you own an ETF that tracks the S&P 500, you’ll get all the big guns like Nvidia, Apple, Microsoft, Alphabet (Google), and Meta (Facebook). You’ll just own them alongside hundreds of other companies that give you the diversification necessary to avoid big meltdowns in your portfolio. Why chase higher returns by taking on more risk? You don’t need that kind of distraction in your life. You’ve got better things to think about.
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