5 buzzy finance trends that could sabotage your investment portfolio
Jumping on the bandwagon can be downright disastrous
The latest smartphone? Upgraded. The next Great American Novel? Pre-ordered. The most popular toy to hit shelves? Already in your kids' playroom.
If this sounds like you, then you probably consider yourself a trend spotter — someone who thrives on getting in on the action ahead of everyone else.
But while jumping on the bandwagon may be good when it comes to discovering new music or fashion, it may not be the best thing for your portfolio — in fact, with your money at stake, it might be downright disastrous.
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That's because the economic headlines are always humming with developments that sound great on paper — but come with a whole host of what-ifs and caveats.
So before you get distracted by the hype, it's important to take a step back and really examine whether they could be a friend or foe to your finances.
With this in mind we've rounded up five buzzworthy finance trends that you may have read about recently — from bitcoin to crowdsourced stock picks — and then reached out to investment pros to fill us in on the pros and cons for each one.
Buzzy finance trend #1: Getting investment-app happy
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These days, you can do just about anything with a swipe. Call for a ride. Train for a marathon. Analyze your sleeping patterns. There's an app for all of that.
Investing is no different. For instance, Stock Market Simulator lets you practice your virtual trading skills using real market data. And with E*TRADE Mobile, you can buy and sell shares straight from your phone.
But when it comes to managing your portfolio, is too easy and instantaneous necessarily a good thing?
Pros: Investing apps make staying abreast of market and economic news as simple as checking the weather forecast — and being more informed is never a bad thing.
"[Apps] are good for learning and collecting information," says Gil Luria, an analyst for investment bank Wedbush Securities. "For example, Google Finance and Yahoo Finance are good tools to help you learn about equities."
And there's one generation, in particular, that might benefit from them. "I think that younger Millennial investors will embrace [investing apps]," says Rusty Vanneman, chief investment officer for advisory firm CLS Investments. After all, it's only natural that the generation that lives and breathes by its mobile devices will want to use their phones to manage their money life too.
Acorn, for example, is an app geared toward encouraging twentysomethings to start a portfolio by giving them the option to round up their purchases to the next dollar. That "spare" change is then placed into an investment account that they can manage from their phones.
Cons: Just as gamers can develop an all-consuming fascination with playing Candy Crush Saga, investors can also grow overly attached to their apps, which may in turn lull you into a false sense of confidence. Translation: Just because you use an investing app on a regular basis doesn't make you an advanced stock jockey.
"Relying solely on investing info from one particular source is not great for investors," says Luria, adding this is especially applicable if you're the type who uses apps to make investing moves based on on-the-fly market information. "A critical [investment] decision should be made in a more comprehensive way." And ideally with advice from a financial professional.
Vanneman points out another way that making knee-jerk trading decisions can be bad for your portfolio. "A lot of investment sites want to get people hooked, and their users can become overconfident [with trading]," he says. "And if you're making more transactions, you'll also have more fees. Even if they're lower fees, they add up."
Buzzy finance trend #2: Buying Bitcoin
If Bitcoin continues to gain in legitimacy, it could bring the world that much closer to the end of physical dollars and cents.
For those who haven't been following its surprising ascendancy, Bitcoin is a form of electronic currency, but its origins are shrouded in mystery. It was created in Japan in 2009 by either a person or an entity — no one seems to know for sure — known as Satoshi Nakamoto.
You purchase bitcoin in units, although industry professionals often refer to quantities of them in the singular, as in, "how many bitcoin will this cost?"
Bitcoin was at the center of controversy because it was used to pay for transactions on the now-defunct illegal drug marketplace Silk Road. But over the past year or so, more and more legitimate businesses have started accepting it as payment.
So can Bitcoin be trusted?
Pros: Mysteriousness notwithstanding, bitcoin is undeniably exciting and pushing the currency envelope. Major retailers like Overstock.com and some Subway franchises now accept them as a form of payment. And there's even a growing network of bitcoin ATMs, in which you deposit physical dollars that convert to bitcoin and fund an online account.
And there's no denying that the digital money has skyrocketed in value. It cost four cents in early 2010, but at one point in November 2013, that price shot up to $1,200 — producing quite a return for early buyers.
Even if you're not willing to purchase bitcoin directly, adventurous investors can find ways to take advantage of the opportunities they provide.
"If you want to tap into bitcoin, you can look into ancillary companies that provide services pertaining to bitcoin, like digital wallets," says David Yermack, a New York University Stern finance professor who teaches a course on bitcoin. "There is a lot of funding flowing into them. There may be returns there to be earned eventually."
Cons: To call bitcoin a risky investment is an understatement. To date, one bitcoin is worth about $355 U.S. dollars — that's quite the tumble from its year-ago highs. "Bitcoin is much more volatile than equities, bonds, and even commodities," says Steven Englander, a foreign exchange specialist with Citigroup.
And, at this stage, no one can truly assess its stability or viability as a long-term investment. "Bitcoin hasn't been around long enough to go through market cycles," says Michele Clark, a CFP® and owner of Clark Hourly Financial Planning in Chesterfield, Missouri. "There aren't enough days of data points [to make a decision] for an investment portfolio. There's not enough market research."
Buzzy finance trend #3: Crowdsourced stock picks
These days we can look to our social networks for just about anything: funding for an exciting new business idea, answers to burning trivia questions, recommendations for where to grab dinner. The list goes on.
So why not harness the power of crowdsourcing for investment knowledge too?
At least that's the thinking behind a growing number of online platforms like Estimize.com, which uses the opinions of the general public (read: amateurs) as well as Wall Street professionals, to predict earnings per share and whether companies are worth the investment.
But is giving credence to crowdsourced investment advice really a wise idea?
Pros: Investors seeking a seal of approval for the power of public opinion need look no further than this study compiled by academics from five prominent business schools in the U.S. and Hong Kong. The researchers found that opinion pieces published by bloggers on the crowdsourced investor forum SeekingAlpha.com predicted stock returns better than Wall Street analysts or traditional financial news outlets did.
And a University of California, Riverside study found an unusual correlation between Twitter activity and a company's stock price and trading volume. Namely, the more people tweeted about a variety of topics related to a company, the better a company's showing was in the stock market. On the flip side, if the tweets tended to focus on a singular piece of news about the company, the stock would underperform.
As precarious as it sounds to put any faith in social media, in Yermack's opinion, there's nothing wrong with a little free crowdsourced advice. "You're not going to do yourself any harm as long as the [crowdsourcing] sites are free," he says. "They're no better or worse than [listening to] the professionals."
Cons: As with any piece of information you find on the internet, take what you read with a grain of salt. "I would proceed with a high degree of skepticism," says Chuck Roberts, a CFP® and owner of Financial Freedom Partners. "Until you [have a reason to] value [crowdsourced] opinions, I would suggest ignoring the advice. There's a lot of scary stuff out there."
And remember that you have to put any stock performance in perspective. "Sometimes [stock pickers] think, 'Hey, I'm making money, so I'm doing a great job,' " says Clark. "What they don't realize is that if their stock rose 10 percent but the market has gone up 12 percent, it's not that impressive."
So unless you're an investing guru like Warren Buffett looking for a company to add to your portfolio, it's probably a better idea to stick with low-fee index or mutual funds that track a larger market index.
Buzzy finance trend #4: Smart beta funds
Smart beta funds sound a bit like an investment in a robotics company, but they're basically an exchange traded fund (ETF) that weighs companies differently from the standard measure most funds use, which is market capitalization, or the company's stock price multiplied by its number of shares.
A smart beta ETF might instead weigh its companies by dividend yield, earnings growth, sales, or even stock volatility, in order to give smaller companies investing appeal — even if they lack the headline-grabbing market cap of big players like Apple or General Electric.
Pros: "The concept is good," says Luria. "Instead of taking the simple weighted averages a lot of indices and ETFs take, they try to add another screen."
And some smart beta supporters say that certain smart-beta weightings have helped create indexes that have outperformed the S&P 500 Index.
Roberts also believes it's something that investors can take into consideration for their portfolios. "It's one tool in an array of strategies and concepts," he says. "Some companies tend to dominate the market-cap valuing — one is Apple — so the [smart beta] concept is a way to calibrate an index. You're giving equal weighting to a smaller company, and there are markets where that's applicable."
Vanneman also sees potential in smart beta funds: "I think that as people get familiar with smart beta funds, you'll see a lot of mutual funds that have smart beta funds eat their lunch."
Cons: Smart beta fund fees tend to be higher than those of traditional ETFs — sometimes as much as 10 times more. And even analysts who recognize that the smart beta concept has wings caution that it hasn't proven itself just yet.
"Beating the S&P 500 every year would be great, but I haven't heard of one [smart beta fund] that has done that for a particularly long [period of] time," Luria says.
The other big beef that smart beta detractors have is the use of the word "smart," because it implies that it's somehow better than other investing strategies.
"It's a marketing gimmick," Vanneman says. "I'd call it 'factor beta' or 'strategic beta.' 'Smart' is too strong a word."
Buzzy finance trend #5: Peer-to-peer lending
Ever ask your friends or relatives for a small loan to tide you over? That's the big-picture idea behind lending clubs, also known as peer-to-peer lending.
Once relegated to the realm of informal arrangements between friends and small communities, the more formal models now enable regular citizens to reap interest payments by making direct loans to other people or businesses.
The most famous such facilitator to date is the Lending Club, which says it's made more than $5 billion in loans possible. By lowering or eliminating the types of fees banks would charge, they purport to benefit both the borrower and the lender. Other well-known peer-to-peer lending clubs include Funding Circle and Dealstruck.
Pros: For investors, who in this case are lenders, the returns don't seem too shabby. "You cut out the middleman, which saves costs, so in theory you're getting better returns," Vanneman says. The Lending Club, for example, says its lenders get returns of 5 percent to 8.67 percent.
Those who'd prefer not to lend directly can also invest in the lending clubs themselves. The Lending Club filed for an initial public offering this August, and market watchers have valued the company around $4 billion.
So as a new phenomenon, lending clubs have high growth potential and, hence, the possibility of strong returns.
Cons: The downside of being a lender couldn't get any simpler: The borrowers may not be able to pay back the money.
"I would expect the default rate to be higher than for a traditional lending institution," Roberts says. "In the triangle of risk, I'd put [lending your own money via lending clubs] at the top. It's risky for the lenders because they don't have the underwriting experience."
You'd also have to be comfortable knowing that you're potentially lending money to people at high interest rates. Some peer-to-peer loans have been known to reach rates in excess of 25 percent.
As for investing in lending clubs themselves, Vanneman points out that with high growth also comes high risk. In fact, notable failed peer-to-peer start-ups include SoMoLend and Funding Community. "Some of these business models aren't going to survive over time," he says.
This story was originally published on LearnVest. LearnVest is a program for your money. Read their stories and use their tools at LearnVest.com.
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