In our last blog we looked at how and why a company that everyone thought was worth very little…suddenly became worth billions to investors. Now, we’ll discuss the issues surrounding this type of investing.
What Happened Next
GameStop’s stock continued to rise, much to the delight of its investors, many of whom were participating through the Robinhood app. Then on January 28, 2021, users were suddenly unable to trade on the app, causing a temporary panic.
Why did this happen?
A common misconception is that Robinhood stopped trading on GameStop to artificially keep the price low and lessen the short squeeze. However, Robinhood had no choice but to halt trading on GameStop for a period of time due to controls put in place by regulatory bodies – the SEC in particular.
It takes time for trades and money transfers to “settle.” Behind the scenes, banks and brokerage firms such as Robinhood are “floating” the trade before the money has settled. However, because there was so much volume and demand it was putting stress on Robinhood to “float” the trades that it was running afoul of SEC rules. This is why it had to halt trading.
Which brings us to an important learning lesson about trading.
The Dangers of Day Trading
Because of the game-like feel of the Robinhood app and others like it, it can be easy for users to get sucked into what feels like a video game – that actually has very real consequences. Many of the investors were unaware of these regulations and felt they had no recourse.
This is when financial education becomes vital. If you were an investor who had thousands of dollars tied up in this activity and suddenly felt like you couldn’t access it and had no one to call…that might make you panic as well. Especially if you were like some of these investors who had gambled with their savings.
The bottom line is that speculative trading in general doesn’t have a place in long term financial planning/ investing. At Denver Private Wealth Management, we believe in investing based off fundamentals and long-term projections.
That being said, it’s important to take control of your financial life and learn about different investment tools and vehicles. While speculative investing is never encouraged, understanding how the financial system and stock market works is always a good idea. So is learning about derivative trading (options) and different ways to make money. If you’re interested in using a small amount of your savings to “learn by doing” then more power to you – as long as you’re aware of your risk tolerance.
And that’s where a financial planner can help.
A Reminder from Uncle Sam
There are also issues that these investors might not be aware of now – but will become painfully aware of by the end of the year.
What many of the investors in GameStop might not understand are the tax implications and potential losses of this type of activity; concentrated investments create concentrated outcomes. That can be a good or a bad thing: putting all your eggs into one basket on an investment which is based on other people following you is not a wise decision.
Additionally, short term capital gains are taxed at ordinary income levels – something that’s lost on a lot of investors. These taxes can create a large drag on your returns and create an unexpected tax bill that will come due at the end of the year.
Talking to Young Investors
If you’re a seasoned investor, there’s a good chance that you already know much of what we’ve discussed in the last two blogs. Okay – maybe the information about Reddit was new, but you’re aware of the risks involved in this type of day trading.
What about your young adult children?
Again, the Robinhood app is specifically designed to look and feel like a game. For the generations of kids who have been raised with video games and iPhones in their pockets, this could look really appealing.
Until they face the consequences they were unaware of.
Having discussions around money in general is an impactful way to pass on good financial habits. At Denver Private Wealth Management, we think it’s important to assist the future generations of our clients with their goals. We want our clients to not only feel comfortable with their own financial futures, but the futures of their children as well.
Ready to have a family meeting to get everyone on the same financial page? Email us at info@DenverPWM.com.
Denver Private Wealth Management is an independent fee-based financial planning practice with 80+ years of experience in the financial industry. DPWM customizes portfolios based on your financial goals and works closely with you, your tax advisors and estate attorneys to form a comprehensive view of your financial situation. For more information or to set up a free consultation, contact us at firstname.lastname@example.org.
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