Meme stocks have been one of the greatest phenomenons of the investing world this year. Investments like GameStop (GME 2.38%), AMC Entertainment Holdings (AMC -2.69%), and Dogecoin (DOGE -2.74%) saw their prices explode overnight, and some investors have made a lot of money from these stocks.
However, meme stocks are more dangerous than they might seem on the surface. Though their meteoric gains make them tempting, there are a few things all investors can learn from them.
1. Timing the market can be incredibly difficult
The difference between meme stocks and growth stocks is that meme stocks' growth is sudden and unfounded. GameStop, for instance, had been on the verge of bankruptcy for years, and it announced it was closing more than 1,000 stores shortly before its price skyrocketed.
Because the stock price doesn't match the underlying fundamentals with these businesses, these gains likely won't last long. Meme stocks grow quickly because retail investors buy the stock in droves, which pumps up its price. Once those investors sell their shares and move on to a different stock, the price will fall.
It's not impossible to make money with meme stocks, but you'll need to be extremely skilled at timing the market. Selling at the exact right moment before the price crashes is incredibly difficult, however, because these stocks -- and the market as a whole -- are unpredictable. If you wait just a day or two longer to sell, the price may have already crashed and you could lose money.
For that reason, you're better off buying solid stocks and holding them for the long term. Healthy companies are likely to see their stock price grow over time, so you won't need to worry about selling at the last second before the price drops.
2. If it seems like it's too good to be true, it probably is
One of the biggest appeals of meme stocks is their enormous price gains. For example, Dogecoin (which is technically a cryptocurrency but also falls under the meme stock umbrella) saw its price surge by nearly 12,000% in a matter of months. It's hard to ignore those returns, and it can be tempting to buy into these types of investments to avoid missing out on the chance to make a lot of money.
However, one of the golden rules of investing is that if it seems like it's too good to be true, it probably is. Meme stocks may see incredible returns, but if their business fundamentals don't align with those gains, that growth likely won't be sustainable.
Although it's considerably less exciting, investing in stocks with steady and consistent returns is a much safer bet than buying stocks that explode over a matter of days. You won't become rich overnight, but you are more likely to earn positive returns over the long run.
3. Putting all your eggs in one basket is risky
When you look at meme stocks' record-breaking returns, it's easy to think about how much money you would have made if you'd invested every dollar you have. But putting all your money behind a single investment -- even a relatively safe investment -- is risky because if that stock flops, you have a lot to lose.
No matter where you choose to invest, it's wise to make sure you have a diversified portfolio that includes a wide variety of stocks from different industries. There's always a chance that one or two stocks won't perform well, but your money is much more protected when it's spread across many different investments.
Meme stocks may be risky investments, but there's a lot to learn from them, too. If your goal is to earn as much as possible in the stock market, you may be better off buying stocks that see consistent growth and then holding them for the long term. You won't become an overnight millionaire, but your money will stay safer and you may see significant earnings over time.