There are new “hot” investments every year. In 2018 it was Bitcoin. In 2021 it was GameStop – a surprise to everyone who thinks that a companies price is somehow connected to their value.
With the recent $GME short squeeze, the cryptocurrency craze, the housing market recovery, and stock growth everywhere, it can seem like every investment out there is going up. Even in my recent 2020 Year in Review, my investments increased 12% for the year.
Even The New York Times is writing about how Everyone Is Getting Hilariously Rich and You’re Not, which can make it can seem like you’ve missed the boat.
“Meme Stocks”, cryptocurrency, and other shortcuts sound exciting but are more often than not fads that will hurt your progress long-term. This post is about how I personally pick which “speculative” assets I include in my portfolio.
Speculation is a dangerous game. To me, speculation is anything that’s not a well-diversified investment in a major diversified asset category: US Stocks, International Stocks, or Bonds.
In my personal portfolio, I too invest in some speculative assets. I limit the amount to 5% of my total portfolio – a small enough percentage that if I’m wrong I’ll still be alright. This 5% usually will go into stocks, and only recently into cryptocurrencies, but the idea is that it’s something I think will grow significantly.
3 Rules for Speculative Investing
Before jumping into speculative investing, there at least 3 questions you should ask yourself:
#1 How much of your portfolio will you accept losing?
Depending on how risky your speculative investments are, there’s a chance they may drop to $0. This is especially true if you’re investing in options or meme stocks. GameStop made it all the way up to $500 a share. If (when?) it drops back to $5 a share, investors that got in at the top will lose 99% of their investment.
If you’re on the wrong side of an options trade, you’ll lose it all.
I personally limit my speculative investments to 5% of my portfolio. Within that allocation, I limit 1% of it to super-speculative investments that could go to $0.
Try to think of this as a percentage of your portfolio – not as a dollar figure.
#2 How will you know when to sell?
Speculative investments can be a rocket ship to the moon or a weight dragging you down. Before you make any purchase, make a plan for when you’ll get out. If the stock triples will you sell? How much does it need to drop for you to sell?
It’s important to know this going in. As we speak Reddit threads are trying to get people to buy more or stay in. You don’t want to constantly need to make these decisions every day! Instead, set up your rules ahead of time.
You can also set rules that allow you to stay in! For example, I invest 5% of my portfolio in speculative investments. If this ever grows to 10% of my portfolio, I’ll sell enough to bring this back down to 5%. That 5% continues to stay invested.
#3 How will you decide what to invest in?
This is a can of worms.
I am not smarter than Wall Street, and unless you’re Warren Buffet chances are you aren’t either. This is why I limit this to 5% of my portfolio. I choose investments here that pass this test:
- Could this become the category leader?
- Is there a lot of room to grow in the category it’s in?
- Do I love it?
- Am I an early adopter?
- Do I want to use this for the next decade?
Investing in this way is very much making a bet. You’re betting that an investment will grow and perform. The companies that I favor are ones that I want to use for a long time from now. Every day there are new cryptocurrencies coming out, but there is no way they meet these conditions for me. Who knows – maybe they do for you.
A number of companies have met these conditions for me. Some of them I decided to invest in, but most were before I gave myself a 5% allocation to invest. For example, I used the Netflix DVD service for years before they made the switch to online. If I were more aware of the above questions at the time, I might’ve looked into making an investment.
Consider making investments in companies that you’re an early adopter of their products.
Every year there are investments that take off and surpass all expectations. Some of these become household names, while others quickly fall as their fad passes. How you handle these fads says a lot about your investing style.
Past Years Strong Companies
Fads are for more than just fashion. In the investing world, there are breakout investments each year that meet my criteria for speculative investing. Here’s a look at some of the recent ones in the past 10 years:
2021: GameStop +6,000% (!!!)
2020: Tesla +743%, Peloton +434%, Zoom +332%
2019: AMD +153%
2018: Apple +78%
2017: Bitcoin +1,272%, Ethereum +9,513%
2016: Nvidia 155% (Cryptocurrencies and VR)
2015: Amazon +163%
2014: Southwest +110%
2013: Netflix +180%, Tesla +368%
2012: Bank of American +115% (Housing Recovery)
2011: Humana +64% (Affordable Care Act)
2010: Chipotle +135%
2009: Lulumeon +320%, Imax +207% (Avatar Release)
All of these numbers are insane. Cryptocurrencies and GameStop are the extreme outliers, but all of these other companies would have been terrific investments as well. Choosing to invest in any of them before they took off would have been a much more profitable investment than the market for that year.
I choose these specific companies and investments not because they were always the highest performing of the year, but because they’re likely companies that you’ve heard about. In 2020, or course Zoom and Peloton went up! They’re both companies that are designed to do extremely well during a pandemic.
Most of these (maybe except Humana) meet the speculative rules above before their large jump. Remember movies before Imax? Or online streaming before Netflix? These were market leaders, and if you were a user of them before the world, you might have known they were going to be big – or wanted them to be.
Don’t Chase Investments
A few years ago I read a book about speculative investing that stuck with me. It focused on the idea that there may be times in your life where you find something (a product, service, app, or whatever) way before everyone else. When that happens, you’re an early adopter. You know more about that company than most of the market. You’re in a position to know more about how the product makes you feel than investors who are looking at the bottom line.
I took this to heart and it’s become the backbone of my speculative investing strategy. Rather than hunting for stocks and reading financial news on movers and shakers, I keep my eyes and ears open to things people are talking about (or won’t shut up about – like Peloton).
How I Find Speculative Investments
As an example, a few years ago everyone I know was talking about CrossFit. Friends that hadn’t ever worked out started going, and I took got caught up in the craze (I still am I suppose). Knowing how it made me feel, I started to look into ways that I could invest in CrossFit. It turns out no companies fit the bill. Rogue Fitness would’ve been closest, but as a private company, they weren’t an option.
Another example would be IMAX. Back in the early 2000’s movies started coming out in IMAX. We were lucky enough to have a full-size theater in Orlando (Pointe Orlando!) that was showing these. We’d constantly check to see what new movies were going to be shown in this format and plan to see them there.
I still get butterflies thinking of the scenes from The Dark Knight where the camera pans over the side of a building. Seeing that was the closest experience to flight I’d experienced in a theater. Unfortunately, I didn’t make the connection at the time and didn’t invest in IMAX.
Southwest Airlines has a cult following. They’re my goto airline when flying domestically. From the reasonable prices to the great customer service, to the ease of using points, to the hilarious comments over the intercom by flight attendants – they’re doing a lot right.
If you discovered Southwest Airlines years and years ago, and felt they were far above most other airlines, then that’d be a great opportunity to look more into the company and make sure their finances matched that feeling.
When I found Southwest, they stock had already had years of amazing growth, and I realized too many people already knew how great they were. Unfortunately I still invested in them, and that stock went down slightly. It helped me better identify what it means to be an “early adopter”.
Things can change fast. Zoom has been around for a few years, but 2020 was the year they took off. There was a moment in early 2020 when everyone was trying to video chat with relatives using Skype, Google Hangouts, Zoom, and other services. Somehow, Zoom ended up the winner in that shootout.
If you had been an avant Zoom evangelist, you might have known they’d win. If that’s you, then this would have been an ideal investment.
Be on the Lookout
I’m always on the lookout for what my next speculative investment will be. In the last 10 years, I’ve invested in Disney, Apple, Tesla, Southwest, Netflix – all never investing more than 5% of my portfolio.
One thing I learned: when I picked investments only because they were going up I tended to do a lot worse. If they were going up, that meant my knowledge of the company wasn’t special. The better option was to find companies I loved that hadn’t yet taken off, but I believed might. The good news is that there are new companies that meet this criterion every year!
So why is this important now?
With the current GameStop, Bitcoin, and cryptocurrency crazes, I’ve been asked by a number of people if they should “invest” in them. I return to the same 5 questions as before:
- Could this become the category leader?
- Is there a lot of room to grow in the category it’s in?
- Do you love it?
- Are you an early adopter?
- Do you want to use this for the next decade?
If you can answer these with a resounding yes, then it’s worth looking deeper into the financials to see if investing makes financial sense. That’s a much larger subject, but just finding investments to be excited is the first step.
So should you invest in GameStop? Hell, no. Or if you do want to invest in it, limit yourself to whatever percentage of your portfolio you’re OK with losing completely. I’ll admit, I invested $1,000 in $AMC (0.04% of my portfolio). I’m OK with losing this amount if AMC goes bankrupt.
What Am I Excited About Now?
While many are geeking out about the blockchain and short squeeze companies, those aren’t the type of speculative investments I’d want to hold long term.
I want to invest in things that are providing value to people.
There’s room in crypto for this! Whenever we travel abroad, it’s no fun converting USD to local currencies. What interests me about cryptocurrencies is the idea that I could wander around the world and use the same wallet without borders. This is where things could go in the next decade with the right tooling to make adoption super simple. I have no idea if this will happen, but I’d love to see it evolve. Whether that’s BitCoin or not remains to be seen.
As far as other companies go, there are no specific companies I absolutely love that meet the above criteria. I really like my Alexa, and I’m curious what will happen in that space – potentially shaken up by systems that better integrate with others via AI (ex: “Alexa, have someone come by and fix my garage door on Thursday”). The VR demos I’ve tried have always left me wowed, but they’ve been just that — demos. The demos I’ve seen aren’t “The Dark Knight”, but more of Adam West Batman. I can see that becoming the category leader in gaming someday – but many years from now.
There are a few categories I’m watching, but don’t have specific recommendations for:
- Augmented and virtual reality
- Marijuana companies
- New social networks that could steal market share from Facebook/Twitter
- Self-driving truck companies
I’m always excited to hear what others are thinking about the future. Andreessen Horowitz, the stellar venture capital fund that has invested in many companies such as AirBnb, Coinbase, Facebook, GitHub, Lyft, Slack, Twitter and more, put out a great video looking into the future that is worth watching.
I’m always on the lookout for new speculative investments. Even if I go years without finding something that meets my criteria it’s better to lay waiting for the right investment than to force yourself into a bad one.
What products, services, companies do you think meet these criteria? Would you invest in them?