By Nicholas Stuller and Peter Mastrantuono
Market bubbles occur when investors’ excess enthusiasm drives asset prices well beyond any reasonable measure of their intrinsic value. Think Tulip Mania in the 1630s or the internet stocks of the 1990s.
One of the driving forces behind market bubbles is The Greater Fool Theory, which posits that investors may be willing to buy clearly overpriced assets (e.g., houses, digital currency) because of their belief that other investors will later buy it from them for an even higher price.
Under this framework, any price, no matter how high, can be justified.
Of course, eventually there are no more “greater fools” and the investors left holding overpriced assets when the music stops lose a lot of money. They become the greatest fools.
Investment and Ethical Considerations
Last week, we discussed meme stock investing and its connection to The Greater Fool Theory. The growing popularity of meme stock investing derives from the moments of fun and opportunity for profit it can provide.
Pursuing an investment strategy that relies on buying overpriced assets with the expectation of selling them at higher prices to bigger idiots, while legal, isn’t necessarily ethical or socially productive. Indeed, it presents several ethical implications that thoughtful and responsible investors should consider before joining in this particular iteration of the “madness of crowds.”
- Misallocation of Capital: Access to capital can change the world, from green energy to new medicines. To the extent investors direct their capital to frivolous or outdated businesses, it denies it to companies with the potential to change the world, frustrating innovation and wealth creation.
- Undermining of an American Competitive Advantage: One of the primary reasons for American domination of innovative technologies and new businesses is our ability to match investors with capital to companies and ideas that need capital. To the degree that we diminish this ability through misguided and foolish investments, we degrade one of this country’s great economic advantages.
- Magnifying Market Darwinism: Participants in meme stock investing take the position, knowingly or unknowingly, that it’s okay to have less experienced and less knowledgeable investors be the financial patsies as long as they make their money. In other words, every con needs its sucker.
- Creating a “Wild West” Atmosphere: When stocks trade wildly for little reason and based on no objective data, it contributes to the belief that the stock market is a casino. This can deter individuals from investing in stocks, undermining the democratization of wealth creation and harming their future financial security.
The truth is that the basic elements of meme stock investing—greed, inexperience, arrogance and excessive optimism—have been around for centuries. It goes as far back as Tulip Mania and the South Sea Bubble to as recently as the housing market before 2008 and meme stocks today.
So, before joining the crowd, consider the ethical and social implications of an investing strategy that ignores valuation, relies on, and takes advantage of, the foolishness of others and undermines the most efficient capital market in human history.
Nicholas Stuller is the founder and CEO of MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. Peter Mastrantuono is a contributing writer to MyPerfectFinancialAdvisor. Peter worked for over 30 years in the wealth management industry, focusing on retirement planning, investing, asset allocation and financial planning.