Americans fell in love with stock trading during the pandemic, pouring billions into a market that only ever seemed to rise. Now that the Federal Reserve is about to start raising interest rates, experts say making money buying and selling stocks is about to get a whole lot harder. Many newbie traders will never know what hit them.
In recent years, investing has become a national pastime. Once the province of Wall Street traders, or at least well-heeled professionals with 401(k)s, stock trading has captured the public imagination with the help of apps like Robinhood. Before long, students started sharing their trading tips between classes and people couldn’t stop talking about cryptocurrency, even on dating apps.
Options trading – the buying and selling of complicated financial instruments typically reserved for professionals – has become a go-to decision for some non-professionals, and non-fungible token (NFT) enthusiasts have started spending thousands of dollars in digital art.
By some estimates, the share of the overall market held by retailers more than doubled in 2020, and the numbers have been steadily rising from there. Fidelity Investments had 31 million total retail accounts in the third quarter of 2021, up almost 23% compared to the same period the previous year.
But the investment boom cannot last forever. And Federal Reserve Chairman Jerome Powell has indicated that the central bank will raise interest rates, possibly as early as March. The move, designed to reduce the amount of money circulating in the economy, could mean fewer dollars chasing the kind of speculative assets that have seen huge price increases in recent years, such as tech stocks and cryptocurrencies.
“Many new investors will face a rude awakening,” says James Angel, professor of finance at Georgetown University. “The stock market is not a one-way upward escalator.”
It was almost easy to make money on risky investments like meme stocks, cryptocurrency, and the high-flying tech sector in recent years. But now that the easy money is behind us, new investors will face a challenge: can they be patient and turn their quick hobby into a way to build long-term wealth?
The risk was rewarded
America’s obsession with investing began even before the pandemic, sparked by a financial innovation: commission-free stock trading. Popularized by investment app Robinhood, in 2019 branded brokerages like Fidelity and Charles Schwab jumped on the bandwagon, helping to bring individual stock trading into the mainstream.
Then the pandemic hit. Confined to their homes during the shutdowns, Americans were looking for a new hobby, from high school students trying to replace extracurricular activities to sports players hoping fill a gap. People with little or no investing experience have taken to social media to learn how to get in on the action. Many of them had extra money in the form of government stimulus checks: almost half of respondents an improvement investigation say they invested some of their stimulus money.
These new investors had reason to be enthusiastic. Trendy companies like Airbnb, Robinhood and Coinbase have garnered massive attention throughout the pandemic for their public market debuts and SPACs have become all the rage on Wall Street. Popular tech stocks have seen their price skyrocket, with cult Tesla stock rising from around $100 per share in January 2020 to a high above $1,200 in November 2021. Meanwhile, cryptocurrency prices continued to set new records.
In January 2021, Wall Street and Main Street couldn’t help but talk about how everyday investors on Reddit had started a bull deal for GameStop, sending the video game retailer’s stock price up from around $20 at the end of 2020 to over $300 at the end. from the first month of 2021. Soon after, other familiar but struggling companies like Hertz and AMC also caught the eye.
“Last year was a year where risk-taking paid off,” says Jack Ablin, chief investment officer and founding partner of Cresset Capital. “The further you went on a branch, the better your investment results.”
But now, he says, we are seeing a reversal of that.
Some investors may be burned
The stock market rally must have come to an end for a while, and there are already signs that the music is starting to stop. In the last three months of 2021, monthly active Robinhood users fall to 17.3 million against 18.9 million the previous quarter. And financial markets have struggled in 2022, with the S&P 500 posting its worst January since the pandemic began and the price of Bitcoin plunging as much as 50% from its November peak. Additionally, we say goodbye to stimulus checks and hello to an expected rise in interest rates.
The Federal Reserve’s commitment to stimulating economic activity by keeping interest rates near zero, Matthew Tuttle, managing director of Tuttle Capital Management, told Money recently. Now Wall Street has to revalue all those assets, and it’s “getting really ugly,” he added.
For the Federal Reserve, raising short-term interest rates is a key tool in fighting inflation. Higher interest rates limit the ability of businesses and consumers to borrow and spend. These limited expenditures help keep soaring prices of goods such as food and cars under control, but they also tend to crush the prices of financial assets, real estate, stocks, and cryptocurrency.
When assets are in the midst of a speculative frenzy – as cryptocurrencies and some tech stocks no doubt are today – a rise in interest rates can prove the pin that pops the balloon. This is essentially what happened during the first dot-com bubble in the 1990s. After the stock market had some of its best years in the second half of the decade, the Fed began to raise the rate in mid-1999. By 2001, the tech bubble had burst and stocks had fallen into a bear market. The tech-heavy Nasdaq did not fully recover for 15 years.
In other words: “The Fed is embarking on an upward cycle to an overvalued market,” as Bank of America strategists wrote in a recent research note. “It ended badly in the other instance we saw this, 1999.”
“It really changed my focus”
When speculative investments no longer seem to automatically generate profits, some new investors are likely to react by doubling down. If so, they could be caught in a dangerous cycle, much like problem gamblers trying to get out of a hole. You don’t have to look far on Twitter to see many already lamenting their same Stock losses.
“They’re excited about the speculative aspect of it, and they’re going for a bigger and bigger hit of that dopamine,” Spencer Jakab, author of the new book “The Revolution That Wasn’t: GameStop, Reddit, and the small investor scam,” he said in a recent interview with Money.
The good news, however, is that for others, even if they don’t get rich quick, the stock trading craze can prove to be an introduction to longer-term investing, emphasizing traditional precepts such as value and diversification.
Timothy Stroud always wanted to start investing, but he didn’t really start until the meme stock craze caught his eye last summer. Stroud, a 28-year-old freelance video editor and retail worker who lives in Houston, Texas, first heard about the GameStop and AMC price spike from his colleagues, and decided to only invest $1 in AMC out of curiosity.
Less than a year later, he’s gone from that small purchase and knowing next to nothing about investing to a portfolio of about 50 stocks and a ton of additional knowledge. Stroud invests with Public.com and says the online community and the offline community of his friends who are also interested in investing have helped him learn more about exchange traded funds, cost averaging and Moreover. Seeing others react to market movements helped him realize the importance of long-term investing, he adds.
Stroud isn’t the only young investor who is now more interested in investing for the future than making a quick buck. The number of Individual Retirement Accounts among Gen Z investors has grown 146% at Fidelity over the past year.
“It really changed my focus from the short term, like what the stock market is going to do tomorrow, to the long term, like what it’s going to do 10 years from now,” Stroud said.
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