In early April, I was at a dinner party with friends and acquaintances. One of them was a guy I had not seen in over a year, and I asked him what he was up to. He dove into a long explanation of how he quit his job and was working to develop a new NFT or Non-Fungible Token (it’s complicated but think cryptocurrency version of art mixed in with a digital intellectual property component). He was obviously excited about it. The other guys at the table started into a nuanced discussion on the value of various popular NFTs. They discussed smart trades they had made and how much their various NFTs were now worth.
I had nothing to add – I have not bought or sold any and had no inkling how many “Eth” a “Bored Ape” was worth. For those not in the know, an “Eth” is short for Ethereum, a type of cryptocurrency, and a “Bored Ape” is one of the original and most popularly traded NFTs. It was clear there was money to be made, and I was out of the loop. Again.
At the time, I remember a feeling of FOMO – the Fear of Missing Out – a sense of anxiety and remorse that everyone else was getting rich and having fun while doing it. They seemed so convinced that what they were doing made “sense” and it is the way of the future. When I questioned the logic and sanity of it all, I was pounced on as someone who did not “get it.” They were on the rocket ship to the next big thing, and I was stuck in a savings account earning 0.01%. Indeed, from the start, I had dismissed NFTs as a fad – or more precisely, as something that involved pure speculation. And as such, it was something I avoided.
That is because I am an investor – not a speculator. I believe something needs to have intrinsic value to be worth investing in. To me, the best type of investment is a business that generates dividends and profits and is likely to do so on a relatively consistent and ongoing basis. Ideally, that business is purchased at a reasonable price; it does not have to be at a bargain level, but that helps. And the opposite is true. I avoid things that do not generate income or do not have a viable business plan.
I also feel uncomfortable when things become wildly popular and speculative fervor runs high. This is when the price of the investment becomes untethered from reality, and all traditional valuation methods are ignored. Think Tulip Mania, the South Sea Bubble, Beanie Babies, or Pets.com. To this historical list, I can now add NFTs, cryptocurrency, and many of the most popular stocks of the last few years: Netflix, Tesla, GameStop, and Peloton (this list could go on, but I think you get the point). Declines in these assets ranged from 40% to 98% (by comparison, the benchmark for the US Stock market, the S&P500, was down 18% at the time of writing).
Speculators are more akin to gamblers. They roll the dice and hope and pray their investment will go up. And up. They are more about the story than the underlying value or the validity of the business model. Investments like Bitcoin and NFTs do not generate any cash flow. They represent technology that allows you to claim ownership and transfer assets easily from one person to another (which are good things but do not create value in and of themselves). It can only go up if someone else thinks it is worth more than what you paid for it.
It is a game of financial musical chairs: at some point, the music stops, and buyers evaporate. And since the investment generates no cash, it is a meaningless investment, and merely a speculative gamble.
On the other hand, companies like Tesla and Peloton do make great products, and they can create value through the sale of those products, but their peak values were based on some astronomical projections. At one point, Tesla was worth more than all nine of the largest auto manufacturers combined. Think about it: to justify its price, Tesla would have to manufacture and sell roughly the same number of cars that the current nine largest are selling now. In the world of investors, that is just an utterly unrealistic assumption.
The goal is to know the difference between investing and speculating. Investing should be thought of as a long-term strategy. The purpose is to build wealth based on solid principles (long-term buy and hold, remain diversified, rebalance regularly, don’t get caught up in fads, don’t buy when everyone else is buying, and don’t sell when everyone else is selling are just a few). That can be hard when the rest of the world seems to be making a killing on something called a Bored Ape.
A colleague of mine joked recently that instead of “investing” $10,000 in this type of fad, he advises clients to take it to Vegas. You’ll still lose your money, but at least you’ll get free drinks.
