Does Speculative Investing Have a Place in Your Plan?

Here in the WealthTenders blogosphere we’re going to make an effort to provide not just foundational personal finance concepts, but also provide perspective on current market events.

One thing that has gotten a ton of visibility over the past few years is highly speculative investing—things like cryptocurrency/blockchain, marijuana companies, the current Gamestop/meme stock saga, etc, have been in the spotlight. This is really nothing new—speculative investing is a tale as old as the market itself. What feels new about the more recent trends is the flow of information, namely how quickly word spreads in our current society thanks to the internet and its powers.

I’ve mentioned in previous blogs some of the FAQs I get from folks who know what I do for a living. The above topics have all made the list at some point—“What do you think about (insert cryptocurrency name)?”, “Are marijuana companies a good investment at this point?”, “Is there still an opportunity with meme stocks?”, “What’s the next Tesla?”. People see the massive gains speculative investors have made with their early entry points and wonder if it’s too late to make the same kind of life-changing investment. Or they want to know where the next play lies.

These questions are a lot more complicated than they seem—there are a myriad of unknowns when it comes to investing in general, and these speculative investments amplify the unknowns (and therefore the risk) quite a bit.

Too often we see people make really bad decisions when they have no guidance on these matters. Some get lucky, as we’ve seen with any speculative investment. Many are left holding the bag, and a lot of them put way more of their money into these investments than they should have. I began my career as a broker in the call center at a large brokerage firm and helped hundreds of clients with what we called “courtesy sells”. A courtesy sell is when a brokerage firm liquidates worthless, de-listed companies on a clients’ behalf so they can take their loss on the investment for tax reasons. A lot of the courtesy sells I completed were for dot-com companies, other former penny stocks, and the like.

Some of those folks told me about how they weren’t thrilled that they lost on their investment but were glad they didn’t risk too much. Others weren’t so lucky. Maybe prudent financial advice could’ve allowed the latter group to participate while not risking too much.

Financial advisors generally aren’t too thrilled when their clients bring up speculative investments. Not for bad reason, either. Most advisors don’t want to be anywhere near the liability of recommending something that may make their client a ton of money but is more likely to do the opposite. Timing speculative investments is extremely difficult, and often these speculative investments are in new things that people (including advisors) don’t fully understand yet. Some of them, like Bitcoin, have persisted and thrived. With that being said there are probably a significant amount of people who FOMO’d (FOMO stands for fear of missing out) into the first Bitcoin run-up in 2018 and sold as it dropped

80% from its highs in 2019. So not everyone who invested in it “won” unless they were financially flexible enough to hold through that period until the past few months (2-3 years). The problem is that when people risk too much of their money on a speculative investment, many end up selling at a massive loss to either cover their short-term financial obligations or cut their losses before they potentially lose all of their money.

Big brokerage firms have advisors on a short leash regarding recommendations on individual stocks, let alone speculative investments. Smaller firms may have more freedom to do so but likely err on the side of caution due to the aforementioned liability. Ultimately, as an advisor, losing your client a lot of money is far more harmful than missing out on exponential returns while still achieving stable growth. It makes more sense for the advisor and for their client to avoid massive risks altogether if possible.

So if you’re interested in these things where can you get answers besides “no”?

For starters, sometimes the answer really needs to be no. Your financial advisor is there to help you grow your wealth and achieve your goals. If you don’t have an advisor, the same principles of personal finance apply. You are on a tightrope of balancing risk and reward. If you cannot afford to risk any of your money at this time on a highly speculative investment you need to hear that from your advisor. It may not be what you want to hear, but ultimately you should NEVER risk money you can’t afford to lose. There’s already risk in the market, ratcheting it up with money you can’t afford to lose could be a recipe for disaster.

Some people do exactly that and get lucky. My metaphor for this is someone who decides to drive drunk instead of getting a taxi/rideshare and is able to make it home. What they did was dangerous and reckless. Just because they made it home safely and saved money/avoided inconvenience or worse doesn’t mean that what they did was smart or should be repeated.

If you do have spare capital to put toward speculation your advisor may explore it with you depending on how they function and advise their clients. It’s important to research and understand exactly what you’re getting into before even considering investing in a highly speculative play. Avoiding succumbing to FOMO is generally a good principle to follow. Having a clear-cut exit strategy is also paramount as the volatility is likely going to be extreme. This is another complication: being right is only half the battle with speculation. You also have to thread the needle of getting in early enough and exiting at the proper time.

As far as how much you should allocate toward speculation, it depends on multiple factors. This includes your time horizon, risk tolerance, cash flow, etc. Knowing those will help you figure out your casino number. I labeled the number as such because it represents how much money you could comfortably walk into a casino with knowing you may walk out with none of it.

Ultimately your finances are not to be played or gambled with. It is possible to simultaneously invest appropriately for your future and speculate without compromising your financial situation. While it may limit your upside potential should the speculation pay off, chasing such returns generally does not end well for the average investor. More importantly, you can accomplish your goals without taking on such heavy risks.

Unsure of whether you are in a position to speculate? Want more information on investments you’re interested in? The best way is to work with a holistic financial planner who understands your full financial situation and is open to providing commentary/research/resources for you to digest regarding what you’re curious about. It’s important to have an advisor who understands your full picture because they can tie what you’re considering back into your overall portfolio to see if it fits in any way. They may tell you it doesn’t make sense and that’s okay. Sometimes advisors are there to protect their clients from themselves, and that’s part of what they’re paid for. See our post regarding finding a financial advisor if you don’t have one. You can also reach out to us through the website with any questions!