Edition #7: Barbell Method, GameStop, App Idea, Mortgage Refi, The Big Short
Hey there, you look like a million bucks GameStop shares today.
You’re reading my newsletter about psychology and money. If you missed a week, you can check out the archives here.
I know you really want to talk about GameStop, full stop.
In a moment, I’ll share with you my layman’s understanding of this week’s frenzied trading phenomena. Geez 2021, not all at once in January will ya?
But first I have to talk about something called the Barbell Strategy. I’ve been marinating on this idea and seeing where it can apply to my life. Investing, relationships, how we spend our time.
The barbell strategy give you an interesting frame of mind for the second piece in this newsletter about GameStop.
Let’s dig in.
🏋🏼♂️ Barbell approach to life
How do we avoid financial ruin while getting a chance at lucky breaks?
Nassim Taleb popularized the idea of the barbell approach, which suggests the following:
Choose extremely safe investments, allocate a small amount to high risk investments, and avoid the boring middle.
Read my exploration of the barbell method and how it can apply to many aspects of life, beyond investing.
Do you have an example of a “barbell approach” you use in life? Hit Reply with your example. I’m also looking for critiques against the barbell approach, so I’ll be updating this article over time.
📊 When will the Game Stop?
A David and Goliath narrative is playing out in the stock markets right now.
GameStop, the declining video game retailer, has seen its stock soar 1,700% since the start of January.
The price has been driven up by a community of individual day traders, namely from the r/WallStreetBets subreddit. As a result, hedge fund titans have lost billions of dollars.
Here’s my layman’s understanding of how short selling works:
GOLIATHS: Hedge funds have been betting that stocks of zombie companies like GameStop and AMC will go down. This is called short selling.
DAVIDS:
Retail investors have banded together to buy these stocks en masse. This increase in demand leads to increase in the stock price, which ruins short sellers. The shorts now owe lenders money, on top of any fees & interest accrued for borrowing the shares in first place.
For a hilarious explanation of short selling for “normal people,” see Avalon Penrose’s video on Twitter.
Some individual traders have made millions off this trade while giving the middle finger to Wall Street firms like Melvin Capital and Citron Research.
The redditor u/deepfuckingvalue is largely credited to have popularized the GameStop trade and even put his investment thesis on Youtube back in July, when $GME was only a few few bucks. He’s made millions off this one trade by now.
But I’ve been wondering — who’s going to be left holding the bag?
Many have bought GameStop, AMC, KOSS and countless other meme stocks at higher prices.
To make things even more worrisome, trading platforms like Robinhood, WeBull and M1 Finance have paused the ability to buy these meme stocks. Some claim that it’s because of their clearinghouse, whereas Robinhood has been blasted on social media for its tepid response (“protecting our business and our customers.”)
As its name suggests, Robinhood is meant to empower the everyday investor…not protect the big boys of finance.
WallStreetBets’ virality has made some people wonder — is any of this illegal? Is there market manipulation or fraud? It’ll probably be hard to prove.
The scrutiny should really be directed towards why hedge funds can trade with impunity. In a searing conversation on CNBC, Chamath Palihapitiya, billionaire investor, highlights this point:
“Why isn’t there more transparency that hedge funds have to make? Every long position, every short position…that was an institutional dynamic created by institutional capital…”
If more financial transparency and accountability comes out of the meme stock story, then I’m all for it.
Here are my takeaways regardless of how this wild ride turns out:
- Technology has made it so that investing tools (Robinhood), community (Reddit), and free-flowing access to information (Twitter), has leveled the playing field for retail investors.
- If we’re surprised by these market dynamics, then we’ll continue to be surprised. It’s only January.
- Free markets are not as free as we think them to be
Personal notes: I had to Google this week how short selling works. Here are my notes:
- Short sellers borrow shares of stocks from a lender. They pay fees to do this, and have to return the shares to the lender at some point in the future.
- They sell the stock at current market price, and plan to buy back this stock for less money.
- If everything goes “right” for the shorts, they buy the shares back at a lower price, then return the original # of shares to the broker. They pocket the difference.
- When it goes wrong: If the stock increases instead of drops, the short seller now owes the lender money, on top of any fees & interest accrued for borrowing the shares in the first place.
💡 Idea: App that helps you invest responsibly
I’m still waiting for someone to develop an app helps traders invest with “responsible math.”
Say that I invest $100, and make $100 for a total of $200. It would be great if an AI can recognize that, and suggest strategies like:
- Playing only with winnings: pocket your gains and invest the remaining elsewhere)
- Tax efficiency: The system would alert you “Hey! You’ve held this stock for less than a year — if you trade, it’ll be subject to higher capital gains tax than if you waited 2 more weeks.”
- Showing market sentiment: How do we know if most people have greed or fear on a stock?
Maybe these tools are already out there — holla at me if you’re in the know.
💸 Money tip of the week: is this mortgage refi worth it?
I was tempted to refinance my mortgage when rates plunged during the coronavirus. But I kept sitting on my ass because it didn’t seem to be worth the effort.
This was the illustration I was missing:
Given a lower mortgage rate, how much faster can I pay it off if I made the same payments as I do now?
I ended up using this mortgage early payoff calculator and realized a few benefits:
- My monthly rate would go lower
- If I kept my current payments consistent, then I would pay off my mortgage ~8 months earlier
- The lower monthly payments makes my financial profile look better if I need another loan
My goal wasn’t just to lower my monthly payments: I wanted to pay a lower total interest compared to my current mortgage, and pay it off faster if I could.
Since there’s a cost to refinance (I paid $995 total to CashCall), I looked at it this way:
- I’m paying for the option to have lower payment. While I don’t think I’ll need to lower my payments, it serves as psychological insurance if shit goes awry.
- If life goes on smoothly and I continue with the same payments, then I would’ve paid off my loan faster, with less total interest.
I suppose this is a kind of a barbell strategy — I’m trying to protect against the downside for one of my biggest expenses.
📚 Book highlight: The Big Short
All this talk about GameStop and shorting stocks made me interested in reading the Big Short again. The book covers the decades-long buildup of structural problems that lead to the 2008 financial crisis.
Incisive point: Wall Street tapped into the desire for normal people to feel wealthy
“How do you make poor people feel wealthy when wages are stagnant? You give them cheap loans.”
When big banks got bailed out, it just highlighted the privilege that wealthy institutions have access to over the everyday investor.
“Success was individual achievement; failure was a social problem.”
The Big Short talks about the rigged game played in finance, and this week is an example of when that game gets exposed.
For now, it seems like retail investors won the day.
End Note
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Should you find anything interesting this week, slide into my DMs. I love finding new things to read through my online community. Also, if you have any question (within reason), hit me up on the Ask Me Anything page.
Until next time,
Oz
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