So far, 2021 has been a rollercoaster of a year for Wall Street. Earlier this year, struggling businesses GameStop (GME 1.06%) and AMC Entertainment Holdings saw their stock prices skyrocket overnight, thanks to a short squeeze initiated by a group of investors on Reddit.
Stocks like GameStop and AMC have given rise to a new brand of investment: the meme stock.
Image source: Getty Images.
Meme stocks are essentially stocks that gain popularity online. Social media platforms like Reddit and Twitter have an increasingly significant role in how people invest, and when certain groups (like Reddit's WallStreetBets community) promote a certain stock, its price can soar.
Some people can make a lot of money investing in meme stocks. However, they're not the right investment for many people. Is 2021 your year to invest in them?
Understanding the risks
While it's possible to see substantial earnings with meme stocks, it's also important to make sure you know what you're getting into. The biggest risk is that they're unpredictable. Often, their stock prices are based more on online hype than the company's underlying business fundamentals.
The more people invest in a stock, the higher its price rises. Investors on social media can artificially inflate prices by convincing as many people as possible to invest in a particular stock. Then the more the stock price rises, the more people want in on it. That causes the price to climb even higher, and the cycle continues.
The problem arises when the price inevitably falls. When stock prices rise well beyond what's reasonable for that particular company, it's only a matter of time before the price plummets. And if you don't sell your investments at just the right moment, you could experience devastating losses.
For example, consider GameStop's first incredible rise earlier this year. The stock skyrocketed essentially overnight. But when the price began to fall, it lost close to 85% of its value in the span of just over a week. If you had invested in GameStop right as it reached its peak, you would have experienced a rough fall as the stock price sank.
Also, keep in mind that hindsight is always 20/20. It's easy to look back on GameStop's situation and think about how much money you would have made if you bought when the price was at rock bottom and sold at the height of its run.
However, timing the market is nearly impossible. It's even more challenging when the stock price has been artificially inflated by social media investors because nobody knows how high the price will climb or when it will fall.
This doesn't mean you can't make money with meme stocks, but it's far more likely you'll lose more than you'll gain.
Where to invest instead
Meme stocks can be incredibly risky. Fortunately, though, there are much safer ways to invest your money.
One of the most effective investing strategies is to buy solid stocks and hold them for the long term. When you invest in healthy companies with strong fundamentals, the stock price is far more predictable. These stocks likely won't experience explosive growth like meme stocks, but they're much safer and more stable.
"If you aren't willing to own a stock for ten years, don't even think about owning it for ten minutes." -- Warren Buffett
As you're researching long-term stocks, be sure to look at factors like the company's revenue growth and whether it has a competitive advantage in its industry. These factors set strong companies apart from the others, and these organizations are more likely to make for solid long-term investments.
When you invest for the long term, you won't make millions of dollars overnight. But if you're patient, you can make a lot of money over time without putting your hard-earned savings at risk.
