If you've been following financial news this year, you've almost certainly heard of something called a "meme stock." Meme stocks took U.S. stock exchanges by storm in early 2021, causing a fervor that even prompted the Securities and Exchange Administration to intervene.
Chasing after meme stocks is not a wise financial strategy for most investors, but learning about the phenomenon can help you understand the risks associated with the stock market and how to determine their own tolerance for risk.
What Are Meme Stocks?
In most cases, a meme stock is one that sees a value increase primarily fueled by social media attention, and not company performance.
The most prominent example of a meme stock is GameStop, a struggling video game retailer that trades under the symbol GME. Gamestop's stock started out the year trading at $19 per share, but by January 28, it hit an all-time high of $483 per share—an increase of roughly 2,442%.
The massive price increase was driven by users of the Reddit social media site who criticized hedge funds for "shorting" the stock—that is, betting on its price to drop instead of rise. Other companies, including AMC, Bed Bath & Beyond (BBBY) and Blackberry (BB), received similar treatment, though effects weren't as exaggerated as they were with GameStop.
The cryptocurrency Dogecoin, which was initially created as a joke, also saw exorbitant gains, going from as low as $0.0075 per share on Jan. 28 to a high of 0.0849 on February 8, providing a gain of 1,032% for investors.
Should You Invest in Meme Stocks?
As with any investment, there's a risk-reward tradeoff when it comes to meme stocks, but the volatility is much higher than with most investments.
For example, while GameStop hit $483 at a blistering pace, the share price plummeted to the mid-$40 range within a week and a half, only to race back up to the mid-$300s a month later. This level of volatility is rare for the stock market, and it's something that many investors would rather avoid.
Meme stocks do have the potential for profit, however. In fact, the social media furor around meme stocks in recent months provided significant short-term gains for a handful of lucky traders, some of whom even became millionaires in the process. Still, it's important to understand that these success stories are rare, and that meme stocks have significant drawbacks, including:
- It's essentially gambling. Speculation has always been a part of the U.S. stock market, and meme traders aren't the first to manipulate stock prices for their own benefit. But in general, stocks have intrinsic value based on the fundamental financial performance of the companies they represent. When stocks are traded at the level of volatility as meme stocks, it's almost pure speculation.
- It's essentially gambling. Speculation has always been a part of the U.S. stock market, and meme tradIt encourages bad investing habits. If you're new to investing, learning the trade through meme stocks can cause you to develop some poor habits. For example, most investors are best suited for the buy-and-hold strategy, which avoids regular trading in favor of long-term gains. Also, making sound stock picks generally requires researching the company, its financials and other technical aspects of the stock's movements. If you're buying stocks simply because a well-known tech CEO tweeted about them, you may end up regretting your decision.
- It's essentially gambling. Speculation has always been a part of the U.S. stock market, and meme tradIt can result in devastating losses. While meme stock prices have launched to incredible highs, they've also crashed significantly. Many investors lost millions of dollars over GameStop, for instance. If you're investing with money you can afford to lose, you may be able to take on a higher risk tolerance. But if the idea of losing the vast majority of your money is unappealing to you, consider a safer investment approach.
Alternatives to Meme Stocks
Meme stocks are extremely volatile securities, and in general, new and inexperienced investors should avoid such high risks. That's especially the case if you haven't spent time learning about how the stock market works and how to make good investment decisions.
Does that mean experienced investors should avoid meme stocks entirely? Not necessarily. There are even ways to invest in meme stocks while mitigating your risk. For instance, fractional shares have made it easy to invest very small amounts in most stocks. Instead of buying one share, which can have a price ranging from a few pennies to thousands of dollars, you can invest based on a dollar amount, buying a fraction of a share instead.
If you're interested in learning how investing works but you don't want to risk a lot, you could purchase a fraction of an individual stock for as little as $1. This allows you to get in on the experience of meme investing without risking too much.
In the meantime, though, it's a good idea to also learn about investing and consider ways to diversify your portfolio and limit your exposure to risk. Some alternatives include:
- Exchange-traded funds: Called ETFs for short, these funds pool money from multiple investors to make diverse investments in stocks, bonds or other assets—or even in a combination of various assets. You can purchase ETFs on major stock exchanges, making them more liquid than mutual funds.
- Robo-investing: Robo-advisors aren't investments per se. But they can make the process easier on you by using algorithms to make investment decisions. You'll provide information about how much risk you're willing to take based on your situation and goals. Then the robo-advisor will construct a portfolio for you, typically through ETFs, effectively taking the responsibility for making investment decisions out of your hands.
- Other individual stocks: If you're intent on investing in individual stocks, there are many that are much less volatile than meme stocks. For example, blue-chip companies have a history of strong financial performance and relatively stable stock prices. They also typically pay dividends, giving you another form of income.
Again, it's crucial to take time to do your research before you make investment decisions. While it won't guarantee you'll make money, it can help you avoid potentially big mistakes.