Will GameStop activism ruin your retirement?
There is currently a new form of shareholder activism and some people are not happy with it. Unlike traditional “passive” forms of shareholder activism (boycotts, proxy fights, and other types of political games), the activities we see with GameStop
You have seen this before. Unlike traditional activism, which tends to run things at the slow pace of an aircraft carrier, finance-based shareholder activism has led to overboard reactions. Judging by statements from members of Congress, some of these reactions may border on market manipulation.
Before explaining this and how it could hurt your retirement savings, it’s important to understand what happened.
Short selling has been a proven method used to promote market liquidity and prevent markets from racing, which often end in a crash. And no one likes a stock market crash.
“Short sellers make markets more complete,” says Robert R. Johnson, professor of finance at Heider College of Business at Creighton University in Omaha. “Short selling allows bearish investors on a company’s outlook to take a position, providing more information and liquidity to the markets. Short sellers often provide valuable “price discovery” to markets. If short selling was not allowed, one could argue that market prices would be determined by “mad optimists”. Short selling allows pessimists to weigh in and impact market prices. “
Remember the part about “nobody likes a stock market crash”? This is not entirely true. Short sellers profit when prices fall. This makes the idea of short selling unethical.
“Some may view short selling as essentially ‘un-American’,” Johnson says, “because short sellers thrive when businesses are in trouble or fail.”
While this may be the sound of the day, it is not the only purpose of short selling. “Short selling is an advanced method that can be used as a means of hedging a position,” says Gregory J. Kurinec of Bentron Financial Group, Inc. in Downers Grove, Illinois.
You can use short selling as a form of “portfolio insurance” (that is, “hedging” your portfolio). This is called being “shorts against the box”. (The now archaic term derives from the days when stocks were in physical form and usually stored in something like a safe.) Although the government has made this practice less attractive from a tax savings perspective to In the late 1990s, there is still some that coverage can benefit a portfolio, especially if it is a tax-free portfolio such as a retirement savings account.
The idea is quite simple, but the execution is quite sophisticated. You will need to consult a professional before trying this.
Here’s the concept: you buy XYZ at $ 50 a share and it suddenly goes up to $ 100 a share. In the long run, you think the stock can easily reach $ 500 per share. You can’t predict exactly when this will happen, so you are reluctant to sell your position. At the same time, you want to protect yourself from a sharp drop in the share price. You are willing to “stay out” of the action for a short time, but you don’t want to do so by selling the action.
One way to do this is to sell the stock short while keeping the position long. If the stock price drops, you can buy the stock needed to cover the short sale for less than $ 100.
Now here is the trick and how you can lose a lot of gains. What if the share price doesn’t go down? What if it goes up to $ 500 per share? The good news is that shorting against the box protects your downside risk. The bad news is that it also freezes your upside potential. It basically locks your price at $ 100 per share.
If it’s not obvious, the real danger of short selling is when you don’t have an existing long position to cover it. In fact, this is how most short sales happen. The portfolio manager bets against the stock. And if this bet goes wrong, well, the sky is the limit.
“There is nothing bad about selling short, but the odds are certainly against the short seller to be successful in the long run, as the stock markets are a positive-sum game, typically increasing by an average of 10% per year. since 1926, “Johnson said. “If you think about it, a short position has limited gains (a stock can only go to zero) and unlimited losses (a stock can keep going up). Suffice it to say, short selling has an unattractive risk / reward profile.
Due to the risk involved, you will often find that short sales are very limited. Frankly, it’s a game not many people can afford to play.
“Short sellers are the exception rather than the rule because of the risk of unlimited losses and because everyone – shareholders, employees, management, board of directors – is putting resources into raising the share price. “says Bankrate.com Senior Economic Analyst Greg McBride, based in West Palm Beach, Florida. “Distressed companies tend to have a share price that reflects this and they also tend to improve their fortunes. Short sellers rowing against this current, so the position usually arose out of strong conviction and special knowledge of a sector or industry. “
You can protect your retirement savings from all of these risks if you simply avoid short selling. But it is not that simple. The simple purchase of an individual security makes you potentially vulnerable to other players who engage in short selling.
“Investors are always exposed to short sales if they buy individual stocks,” says Cindy Couyoumjian, president and CEO of Cinergy Financial in Tustin, California. “In other words, anyone who owns stocks, or your investments are in the 60/40 portfolio, you will be exposed to the potential negative effects of short selling.”
Not all individual actions carry the same risks. Unfortunately, the ones with the biggest drawback may be the more popular stocks.
“Retirement savers could be exposed to short sellers by investing in risky stocks,” said Daniel Goodman, a professional day trader based in Los Angeles. “Companies that haven’t been around for a long time and have grown too quickly are extremely overvalued. Any bad news from the company can cause the stock to drop sharply. “
Yet even if you only invest in mutual funds, you are not completely immune from a short selling frenzy.
“Retirement savers could be exposed to short selling through mutual funds,” says Chris Abrams, founder of Abrams Insurance Solutions in San Diego. “Many 401 (k) and Roth IRAs include mutual funds that work in much the same way as hedge funds. Mutual funds will engage in short selling, which can have a short and long term impact on a retirement account. “
Looks like there’s nowhere to hide? Rest assured, some risks still exist and can only be minimized. Exposure to short selling seems to be one of those risks. There is, however, a reason to be optimistic, especially if you are in a conservatively managed mutual fund.
“Ideally, retirement savers shouldn’t be particularly exposed to short selling for two reasons,” says Richard Barrington, senior financial analyst for New York-based MoneyRates.com. “One is that retirement investors should buy for the long term, and therefore relatively indifferent to the temporary disruptions created by short selling. The second reason why retirement savers shouldn’t worry too much about short selling is that they should have well-diversified portfolios, which significantly lessens the impact of stock price fluctuations.
Short selling might be a game you can’t stop, but you shouldn’t be concerned.