If it seems too good to be true…it probably is

In late 1999, as I was starting my career in financial services, I went to play a round of golf with a good friend of mine, and he brought along a neighbor of his to join us. I was in my late twenties, and the guy was just a few years older than I. He lived in a house in the Uplands in Berkeley, a few doors down from my friend who lived in an in-law apartment at his parent’s home. My friend’s neighbor had inherited the house, which must have been worth a lot and I remembered being impressed that someone his age could afford to live in that neighborhood on his own. We got to talking, and I asked what he did for a living, to which he replied that he was a day trader. He went on to explain that he had recently quit his previous day job, and spent a only few hours each day trading tech stocks. I was immediately struck by his description of how easy it was, and how, according to him, anyone could make a killing doing the same thing.

Around that same time, a relative of my wife (at the time my fiancée) generously gifted her a small amount of money, and suggested that she too should invest it in some of the high-flying tech stocks that he had been making a killing on by day trading. The check came with a list of names that it suggested were ‘can’t-miss’ prospects. It was a veritable who’s who of now infamous names, and to be fair, also included a few that actually stood the test of time. Having already begun to be indoctrinated myself, into the gospel of long-term indexing, we decided that instead of investing it into those individual tech names, we would drop the money into an S&P 500 index ETF, where it stayed until we used it as part of the down payment on our home many years later.

Shortly thereafter, the bottom of what we now call the dot-com bubble dropped out, and the recession of the early 2000s began. My wife’s relative had only been gambling with some discretionary cash flow, so he ended up fine. But my golfing buddy it turned out, had been so over confident in his stock-picking abilities, that he had leveraged that house in the Uplands he had inherited, in order to obtain more capital for his day-trading operation. So when the bubble burst, his stable of high-flying tech companies got crushed, he had to put his house on the market a few weeks later, and I never saw him again.

For me, what this extraordinary time right at the beginning of my career did was to cement my belief that successful investing was all about time in the markets, not timing the markets. Also that diversification, keeping costs low, risk tolerance and finding the right mix of asset classes – these are the keys to long-term success in investing.

I’ve never forgotten those lessons that formed me in the late 1990s, and so, earlier this month when I first started hearing about crazy price swings in Gamestop stock, and a so-called ‘retail revolution’ in the stock markets, I got a bit of deja-vue. The whole recent episode has been eerily similar to those dot-com days. And the sad part is, it’s never the institutional traders or the large hedge funds, who are supposedly the targets of the retail revolution takedown, that ultimately get hurt. It’s some guy in a nice house that he inherited, who thinks he can get rich quick because investing is easy, and because ‘it’s different this time.’

A few days ago, I read about a young man who borrowed $20,000 to invest in Gamestop thinking it couldn’t lose. Of course he got caught when it plummeted after brokerages halted trading in the stock, and now he’s on the hook for the money he borrowed, with no way to pay it back. It reminded me of my golfing buddy and that beautiful house he lost back in ’99.

That’s why we so often say that the four most dangerous words in investing are ‘it’s different this time,’ because each one of these cycles always feels different. And each one actually is a little bit different, which is exactly why it is so easy to fall into the trap of thinking we can predict how it will go.

For the average investor, picking a few stocks here and there and having a little fun in the markets with some discretionary cash is likely harmless, as long as you understand the difference between when you’re gambling and when you’re investing. The problem is that too often, most folks just don’t know the difference. In times like these, I’m reminded of something my mother used to tell me all the time- “If it seems too good to be true, it probably is” – good advice to always keep in mind.