Fad investments proliferate during good financial times, according to James Ragan, director of wealth management research at D.A. Davidson & Co.
“It seems that when the stock market and real estate markets are going well, there are more opportunities for fads to arise,” Ragan said, adding that these fads often turn out to be bad investments. “A good market creates more fertile ground for fads to take hold. If people have not been invested, they feel like they are missing out. But this is also a good time to build a good portfolio.”
The most well known fad, meaning an investment that is unsustainable over the long term, was probably the dot.com bubble of the late 1990s, when there was a mad rush for buying stock in any company that had the slightest exposure to the internet. The bubble made some people rich, but it cost a lot more their fortunes.
Fads or bubbles are characterized by a temporary excessive enthusiasm for a certain investing style, he said. For investors who know when to get in, and get out, fads can provide a portfolio boost. However, if investors get caught up in the hype, they're likely to suffer the crash to which nearly every fad succumbs, he said.
“It is very difficult for someone with no investing experience to value these types of investments,” Ragan said.
The surges around marijuana investments since the election cycle of 2016, the continuing enthusiasm for bitcoin and blockchain investments, and the interest in oil drilling and fracking five years ago can be examples of fad investing, he added.
In some cases the categories themselves might be sustainable and many companies surrounding the categories have long-term prospects, but many firms just pop up on the landscape with no real value or revenues.
“The value of some of these companies gets bid up just because of the rush of investors in the market segment,” Ragan said. “It can be a gold rush mentality, which builds up the valuation of a company or market segment. If the investor does not have experience, he or she should not chase fads.”
Advisors need to ask clients why they want to buy a particular stock and if the investor does not have a good answer, he or she should leave it alone, Ragan said. Legitimate companies expand into new markets, but others just jump on the bandwagon and have no real product or revenues to back them up.
Investors need to do a little research and read the company reports before investing, he added.