Learn To Invest
Stocks Special Reports LICs Credit Funds ETFs Tools SMSFs
Video Archive Article Archive
News Stocks Special Reports Funds ETFs Features SMSFs Learn
About

News

Are millennials changing the rules of investing?

Erica Hall  |  03 Jun 2021Text size  Decrease  Increase  |  
Email to Friend

If you having been watching investment markets in recent times it is entirely reasonable to ask, has the world gone mad? Much of it seems to point to millennials, digital natives who tend to find their investment advice from interacting with others on social media platforms such as Reddit, TikTok and Twitter. And it’s causing some surprising outcomes.

Take GameStop (GME) for example. Investors banded together via group chats on social media with a very unconventional investment motivation. They did not invest to make money, rather they invested to make a philosophical point, to send a strong message to Wall Street that they disagreed with their short position in this stock. In a hyperconnected world, retail investors can work together and produce enough power to move market mountains.

Interestingly, investors through their collective actions of supporting GameStop may end up losing money. Yet this does not seem to be a major issue since it was all about making a point. This contradicts assumptions financial models make relating to utility. The models expect investors will be self-serving and look to maximise their utility. Utility defined as achieving the highest satisfaction, typically maximising return on investments, is considered a good proxy to maximising utility. What happens when that is no longer the case?

The utility or joy obtained by investing in GameStop was not in maximising returns, rather it was in the collective power of likeminded people bringing Wall Street giants, specifically hedge funds who had shorted the stock, to their knees. It was successful. The stock price rose approximately 1700 per cent, forcing hedge funds to cover their short positions and realise large losses.

When financial models were created it is unlikely academics would have been anticipating such "irrational" behaviour from investors. And yet, here we are. The question is: was GameStop an anomaly or should we expect more of this kind of philosophical investment action in the future? Do long-standing investment theories such as the Efficient Market Hypothesis, Capital Market Pricing Models and Modern Portfolio Theory even make sense anymore? Are the assumptions within these models out of touch with the way today’s investor thinks?

Some assumptions built into traditional financial models are:

  • Investors will look to maximise utility. This may still hold true as long as you consider utility beyond maximising returns.
  • Investors will demand compensation for risk taken. Risk doesn't seem to be even on the radar currently for this cohort. There are several possible reasons for this. Strong upward momentum in the stocks they have been investing in means they have potentially banked a lot of financial success. Making a philosophical point may make losses more palatable. Or it might be a short-term anomaly rather than a long-term structural change.
  • Diversification can help minimise risk. As Elon Musk has repeatedly said in relation to the so-called people's cryptocurrency, DogeCoin, who wants to minimise risk when single investments are "going to the moon!". Concentrated positions all the way! That said, Elon seems to have been tempering his messaging more recently, which has resulted in a significant price correction in the crypto currency market.
  • Information is efficiently dispersed by markets via share prices thereby nullifying arbitrage opportunities and active management. Obviously at its extreme, this theory does not hold up or otherwise we would just all be invested in index funds. Information flows more freely than it has in the past; however, the market noise is louder. How do you make sense of all the information you can access? You find a group or a guru on social media to follow. Which guru do you listen to? Do they owe their success to their skill as investors or because they can make the crowd follow their investment recommendations? Do they have any conflicts of interest? As an investor you have two crucial decisions to make: when to invest and when to divest. Generally social media guru tends to focus on short-term speculative opportunities, high-risk trades with hopefully high rewards. Get the timing wrong and it can really hurt.

While academics acknowledge financial models and their assumptions are not perfect and may not always work in practice, such models are still widely used as the basis of portfolio construction and price discovery.

Investing Compass
Listen to Morningstar Australia's Investing Compass podcast
Take a deep dive into investing concepts, with practical explanations to help you invest confidently.
Investing Compass

Where the rubber really hits the road is when you consider investor behaviour, namely how investors make decisions and why. This is covered by the study of behavioural finance, which fills the gap between rigid economic and financial models and their "perfect" expectations of human behaviour, with more reasonable expectations based on observed human decision-making in behavioural finance.

While we humans do the best we can we don't always make the most optimal decisions; typically we have imperfect information, we are time poor and cognitively challenged.

Unusual behaviours observed in this market can be explained by behavioural biases such as:

  • Herding. Following the crowd (on social media), investing into whatever it is they tell you to invest into and FOMO, if you don't act you may miss out on all the riches that being a part of the herd will bring.
  • Recency. Placing more value on the most recent experience (rocketing prices) and expecting that it will continue.
  • Confirmation bias. You only seek out information that backs up your point of view. All the stocks I am holding are "going to the moon" because all the posts and media reports I read, and people I speak to, say so. Anyone who has a different point of view does not know what they are talking about. Such as the Governor of the Bank of England, Andrew Bailey, cautioning weeks ago that cryptocurrency as far as he was concerned has no intrinsic value and investors must realise they could lose all their money. He may be wrong, but it is an opinion worth considering.
  • Overconfidence. Thinking investment success is a result of their own skill as an investor can make people do counter-productive things such as take on excessive risk, fail to diversify, and trade more frequently—all of which can result in loss of capital.

Technological advances are affecting the way people access information and make decisions. As the democratisation of information continues it may create more unexpected behaviours, potentially increasing volatility. Millennials seem to be making their mark on financial markets, eschewing traditional investments, rejecting large institutions, embracing new asset classes and companies. This group can easily behave as a collective power via social media, which can produce some unexpected outcomes, at least for now.

is Senior Manager, Adviser Solutions, Asia-Pacific for Morningstar Investment Management

© 2021 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'regulated financial advice' under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information, refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

Email To Friend