From young investors to large money managers, everyone’s talking about meme stocks. That’s quite a feat for a term that was created less than a year ago.

As financial advisors, we’ve been asked multiple times about meme stocks like GameStop and AMC. What are meme stocks? Should I invest in them? Are they volatile? Where do they fit in a long-term financial plan?

When thinking about whether or not to invest in meme stocks, it’s important to remember that everyone’s financial situation is different. As with all elements of a financial plan, there is no one-size-fits-all approach or blanket recommendation.

That said, there are some key things to consider and know about meme stocks before putting your hard-earned money on the line. 

What is a meme stock?

Well first, what’s a meme? Difficult to explain but easy to recognize, memes have taken over the internet. First used in Richard Dawkins’s The Selfish Gene, memes are described as “cultural artifacts that spread quickly and uncontrollably within and across cultures.”

From mocking Spongebob and distracted boyfriend, to Crying Michael Jordan and Grumpy Cat, these captioned photos and images have filled feeds across social media platforms.

If you’ve spent much time online, then you’ve likely seen (and probably laughed at) a meme.

Much like regular memes, meme stocks are stocks that have become popular through social media conversations and communities. As we explain later on, meme stocks are unique in the investing world because their soaring share prices are not driven by underlying business value. Instead, their popularity (and value) is socially driven.

Meme stocks attract large numbers of investors (typically young and self-managed) through viral social media posts. And the people who usually invest in meme stocks choose to invest in them because of the social camaraderie, not because of valuation models or macroeconomic indicators.

How did meme stocks start?

To understand the history of meme stocks, you don’t have to go back very far. In fact, at the beginning of 2021, few people even had the idea of what meme stocks could be.

The phenomenon started on Reddit, a social media platform made up of various forums and conversations — also known as subreddits — based on specific topics and interests. 

Specifically, the first meme stock started from a discussion on the WallStreetBets subreddit, a forum focused on stock trading. It was there that 34-year-old retail investor Keith Gill (who is known on the platform by an unpublishable pseudonym) shared videos and posts explaining why he thought people should invest in GameStop (GME).

As Gill’s ideas gained attention and interest, the first meme stock was born. Redditors (that is, Reddit users) banded together and purchased large amounts of GameStop stock. And over the course of three weeks in early January, GameStop’s stock price skyrocketed from $17.25 per share to $483 per share.

So, that’s the story of how meme stocks started, but why did people latch onto Gill’s advice and decide to invest their own money? Beyond the proliferation of social media (and memes), a few other factors came together to create the right environment for meme stocks to gain steam, including the rise of retail investing, easier access to commission-free trading, growth in populist sentiments, and — oh, by the way — a global pandemic.

Retail investing and commission-free trading

Historically, most investment trading has been driven by institutional investors (like mutual fund managers, hedge funds, and investment firms). In recent years, however, there has been a surge in “retail trading,” or trading that is done by individuals who buy and sell stocks on their own.  

As you might expect, retail investors typically invest much smaller amounts of money than institutional investors, and they are also more likely to dabble in investing rather than focusing on it full-time. So while there’s a large number of retail investors, the percentage of all trading activity they represent is still relatively small compared to institutional investors. 

With the rise of social media, retail investors have been able to join forces, compare notes, and combine efforts much more quickly than ever before. This certainly contributed to the development of meme stocks.

As interest in retail investing has grown, so too have options for individuals to engage in day trading. Gone are the days of the 1990s tech boom when daytrading required high-powered PCs, six computer monitors, and expensive trading software. Apps like Robinhood and other zero-commission online broker apps have democratized the process of buying and selling stocks and removed many of the traditional barriers for retail investors.

There’s little doubt that commission-free trading apps and meme stocks have a symbiotic relationship. These apps have grown in popularity because of meme stocks, and meme stocks have grown in popularity because retail investors have access to these apps. 

In addition to being relatively easy, the combination of commission-free trading apps and meme stocks enables a kind of gamification for investing, adding to its appeal from an entertainment perspective.

And who wants to play that game? People with a chip on their shoulder, and people who are willing to gamble in an attempt to “get rich quick.”

Wall Street vs. Main Street

In many ways, the narrative around meme stocks has become Wall Street vs. Main Street. As a wave of populism swept the country — particularly among younger Americans — many people became interested in exploring and supporting ways to upend the capitalistic establishment.

In part, those ideals contributed to the meme stock movement. Retail investors wanted to find a way to take advantage of a system (Wall Street) that they believed had been taking advantage of everyday people for decades.

They found an opportunity to do this by creating “short squeezes.” 

To understand a short squeeze, we'll explain what it means to "short" a stock or to short-sell. Basically, short-sellers are investors who anticipate (or bet) that a stock’s price is going to decline rather than increase.

When an investor bets on a stock’s price to fall, they short-sell the stock. To do this, the investor borrows shares of a stock, sells them at the current market price, and then (if the trade works out) buys the stock back at a lower price before returning the borrowed shares to the original lender. The difference between the original price they borrowed (and sold) the stock at and the price they bought it back at is profit for the short-seller.

To illustrate how this works, here’s an example:

  • A short-seller borrows 200 shares of a stock priced at $20 per share (total value is 200 * $20 = $4,000). 
  • When borrowing the stock, the short-seller believes the stock is overvalued and expects the stock’s price to fall by $5 per share.
  • The short-seller immediately sells all 200 shares of the borrowed stock at the initial $20 per share price and now holds $4,000 in cash.
  • If the short-seller’s “bet” comes to fruition and the stock’s price drops, they will buy back the stock at the lower price. For this example, we’ll say it does drop by $5 per share (from $20 to $15).
  • Pulling from the $4,000 from the initial sale, the short-seller buys back all 200 shares they borrowed (and sold) for $3,000 (200 * $15 per share).
  • The short-seller then returns all of the borrowed stock — now valued at $3,000 — to the original lender.
  • The difference between the original stock price when borrowed ($4,000) and the price that the short-seller repurchased the stock ($3,000) is profit for the short-seller. In this case, it’s $1,000.

The most important thing to know about short-sellers is that they believe a stock is overvalued when they borrow it and that it will drop in price before they have to return it. To make money on the short-sell, they need the borrowed stock to drop in price before they return it to the lender. If the stock price rises (instead of falls), then the short-seller loses money.

Using the same starting scenario as earlier, here’s what that might look like:

  • The short-seller immediately sells all 200 shares of borrowed stock at the initial $20 per share price and now holds $4,000 in cash.
  • But instead of the stock’s price falling as the short-seller expected, the stock’s price actually goes up. At first, it goes up to $25, and the short-seller decides to hold their position, hoping the price will soon go down.
  • Then, the price continues to go up, now to $30. 
  • The short-seller decides to cover their losses and re-buys all 200 shares at the new $30 per share price (200 * $30 = $6,000 total).
  • The difference between the original stock price when borrowed ($4,000) and the price that the short-seller repurchased the stock ($6,000) represents a $2,000 loss for the short-seller instead of a profit.

The important distinction to make between a typical stock purchase and sale (a “long” trade) and a short trade is that the worst case scenario for a long trade is that the stock goes to $0 and the trader loses all of their initial investment. A short trader, on the other hand, loses more the further the stock price increases, so their losses are theoretically unlimited.

To make matters riskier, most short-selling happens using leverage, where the bank or institution facilitating the trade allows the trader to borrow more stock than the collateral they contribute. So for the hypothetical $4,000 trade above, the trader may have only contributed $1,000 of their own money. This only amplifies the magnitude of potential gains and losses.

So, recognizing that a short-seller can lose money by shorting a stock brings us to the concept of a short squeeze. A short squeeze happens when something causes the price of a stock with high short interest (a high number of short-sellers “betting against” the stock) to increase quickly. 

In some cases, the short-sellers will voluntarily exit their positions by buying back the stock to minimize their losses. Others will be forced (“squeezed”) by their banks to either close their positions or put up more collateral to cover their mounting losses. As this happens, more and more short-sellers become unwilling buyers of the stock, creating a snowball effect of upward pressure on the stock price. This is what’s known as a short squeeze, and it is a short-seller’s worst case scenario.

Back to our GameStop meme stock example. Retail investors from the WallStreetBets subreddit wanted to find a way to make their own profit while also sticking it to traditional Wall Street investors and hedge fund managers. So, they worked together to create a short squeeze.

Specifically, GameStop’s stock had been floundering and underperforming for years because of a trend toward downloading video games directly from consoles vs. going out to buy the physical game discs. The threat to GameStop — and many other brick-and-mortar retail establishments — was magnified as consumers stayed home during the pandemic.

Faced with these business threats, more and more short-sellers believed GameStop’s stock would continue to fall. There was high short interest in GameStop's stock.

To get back at the Wall Street hedge fund managers who were betting against GameStop, Redditor retail investors aimed to drive up the price of GameStop’s stock and create a short squeeze.

This sense of community around a common goal created both social camaraderie and a bit of entertaining gamification for retail investors. As they banded together to buy more and more shares of GameStop stock, short-sellers exited their positions to cover their losses. 

This ultimately led to a huge rally in share prices for GameStop. As the stock’s meteoric rise caught the attention of mainstream media and people outside of Reddit, the momentum went viral (much like an actual meme) and became self-sustaining. More and more people bought shares, not only to “stick it to Wall Street,” but to try and make a quick profit.

With all of these things coming together — social media virality making it easier to reach more people, technology advancements making it easier to trade investments, and populist sentiments driving a desire to get back at Wall Street — the momentum for meme stocks amplified. 

The final ingredient? Money for people to invest.

Stimulus checks and excess cash

As the pandemic upended the global economy, it led to significant layoffs and a sharp rise in unemployment. The result was a lot of people and businesses struggling financially. To help ease the burden, the U.S. government issued multiple rounds of economic relief involving stimulus checks, tax credits, increased unemployment benefits, and more.

Many people relied on these government-funded initiatives to make ends meet. And a lot of businesses needed the aid to keep their doors open and pay their staff.

However, many others weren’t actually impacted in a significant financial way by the pandemic. Plenty of Americans kept their jobs and continued to bring home steady paychecks.

Because of the government aid, many of these people found themselves with even more cash than expected. And they also found themselves wondering what they were going to do with it.

As humans, we tend to place less value on quickly gained money than on money carefully accumulated over time. Many Americans chose to use their newfound “play money” — up to $3,400 for a typical adult between the three rounds of stimulus checks — to pursue investment opportunities that perhaps they were unable to chase before. 

Daytrading was no longer reserved for the institutional elite. The excess cash was the gasoline poured onto the already fast-spreading meme stock fire.

How are meme stocks different from “normal” stocks?

At the end of the day, meme stocks are still just stocks. Technically, they are bought and sold in the same ways other stocks are bought and sold. The primary differences are the way people assess the value of meme stocks — or, the reasons people decide to invest in meme stocks — and their long-term predictability.

A meme stock’s value

Any given stock is typically valued based on some underlying criteria directly related to the success or failure of the product or company. For example, when the COVID-19 pandemic first began to surge, publicly traded companies that produced products like sanitizers and remote-working technologies experienced a surge in stock prices because the underlying businesses were positioned to profit from the pandemic. Conversely, companies specializing in travel and hospitality saw their stock prices plummet. 

This is reflective of how a capitalistic economy and our stock market usually work. The value of a stock is often tied to the value (or predicted value) of a company and its products or services. An exciting, innovative product announcement can help lift a stock’s value, just as a scandal or PR crisis can send a stock’s price barreling down.

Meme stocks are different. Very different. There’s no indication that a meme stock investor’s interest has anything at all to do with the actual company’s value. 

In many ways, it’s almost the opposite of how institutional investors decide to buy stocks. Based on the limited history of meme stocks, what we’ve seen is that they’re mostly associated with companies that have diminishing value, depressed stock values, and bleak futures.

But this doesn’t matter to a meme stock investor. Their motivations are separated from the success of the company. They aren’t buying the meme stocks because they think an unprofitable company is going to start making money again or have long-term success.

They’re most commonly buying meme stocks because:

  • They get a lot of intrinsic social and entertainment value from wreaking havoc on institutional Wall Street investors; and/or
  • They are wishfully buying into a get-rich-quick mentality and hoping they can ride a meme stock’s wave before it crashes

Forecasting a meme stock’s future

Beyond their current valuation, meme stocks are also different from non-meme stocks in that they are incredibly difficult to predict.

Typically when an investment manager or skilled day-trader is building or rebalancing their portfolio, they consider economic indicators and the financial condition of individual companies to make strategic or financially optimal decisions. They use this information to make educated guesses about which stocks are going to increase in value or potentially outperform the market, and those are the stocks they buy.

Meme stocks, on the other hand, are by nature nearly impossible to forecast. In a way, all individual meme stocks are black swans — or unforeseen market events. 

If you are somehow able to pinpoint which stock will become the next meme stock and invest in it early on, then there may be something to gain. But much like trying to predict the next trend to take over Instagram or TikTok, there’s no reliable way to determine what the next meme stock will be.

And once a stock “becomes” a meme stock, it’s equally difficult to determine when it will reach its peak. Because meme stocks depend more on social value than a company’s performance, their future is unpredictable. 

The stock will likely continue to increase until everyone who is interested in participating in the meme stock movement has already participated or retail investors lose interest and move on to something else. Neither of those has anything to do with macroeconomic factors or the stock itself.

In many ways, meme stock investors seeking to gain a profit are simply subscribing to the Greater Fool theory — that even though the price is clearly detached from economic reality, someone will come behind them and be willing to pay even more than they paid for an overvalued meme stock. That game may work for some, but only until there are no greater fools left.

Are meme stocks right for you?

Meme stocks aren’t for everyone, and we would argue that putting money into them falls more in the category of speculation or gambling than investing. But that doesn’t mean they aren’t right for anyone. Everyone’s financial situation and goals are unique and highly personal. To determine whether meme stocks are right for you, here are some things to keep in mind.

Risk tolerance

Every stock comes with some level of risk. Most financial planners and investment managers make investment decisions for their clients based on their risk tolerance assessment. 

By their nature, meme stocks are high-risk. This is largely because of the unpredictability associated with them. As mentioned earlier, there’s not a scientific or data-driven way to forecast when a stock is going to “become” a meme stock or when a meme stock is going to reach its peak (and begin to lose value).

In this way, investing in meme stocks is very much a gamble and can be stressful for risk-averse investors. For this reason, meme stocks may not be a great fit for you if you have a low risk tolerance.

Long-term rate of return

While long-term investors are more focused on how their investments will perform over years or decades, other investors try to find ways to make money off their investments very quickly by “timing the market.” Attempting to time the market can be quite risky (and time-intensive), and there is extensive research suggesting that almost no one can do it consistently.

Although the history of meme stocks is quite short, there isn’t any indication that they will offer attractive long-term rates of return. That is, meme stocks aren’t stocks you’d likely want to hold for an extended period and expect to continuously build wealth.

Of course, there certainly are examples of people who have profited from meme stocks. But given their inherent risks and volatility, it’s difficult to hold onto them for long periods.

If you’re looking for investments that will offer long-term rates of return, meme stocks likely are not the best choice for your portfolio.

Progress toward goals

Another thing you will want to think about before buying meme stocks is progress toward your own financial goals. This is important because investing in meme stocks is similar to gambling. So, any money you invest in meme stocks should be money you’re prepared to lose and can live without.

Because of their risk, meme stocks present a threat to your long-term financial plan. This is especially true if you don’t have excess savings or you haven’t met some of your key targets, like retirement savings goals or an emergency savings fund. 

As a legal fiduciary, when we make investment recommendations for our clients, we do so based on what’s going to help their portfolio grow and help them reach their lifelong financial goals. And if you’re relying on your investments to help you reach long-term goals for your financial plan, then having anything beyond a little bit of play money in meme stocks puts your plan in jeopardy.

If you do decide to “play the game,” much like a trip to Vegas, it’s crucial to go in with an exit plan and an expectation that you could very well lose money. Before taking the plunge, decide which benchmarks will force you to exit your position. For example, if you’re fortunate enough to experience gains, at what price will you lock in your winnings? And if the price falls, how far will you let it fall before exiting your position and covering your losses?

Because investing in meme stocks is a speculative gamble, emotions can loom large. To reduce the risk to your long-term financial goals and limit emotional decision-making, you should formulate an exit plan and stick to it. Otherwise, your future financial goals are at even greater risk.

Values-based investing

Life isn’t always about making money (does that sound weird coming from a financial planner?). You will want to find balance between planning for tomorrow, living for today, and feeling good about where you spend your money.

From charitable donations to personal gifts to ESG investing, a person’s values — in addition to their monetary goals — play a part in their financial priorities.

Undoubtedly, values are a significant component for many people who decide to invest in meme stocks. Whether it be social value, entertainment value, populist ideals, or the desire to support struggling businesses you believe in, meme stocks can be viewed as a manifestation of values-based investing. The key in these cases is being realistic about the financial implications before you jump in.

Our investment philosophy

As fiduciaries for our clients, we seek to make financially optimal recommendations that are always in our clients’ best interests. Without an explicit values-based connection to meme stocks, we do not typically recommend that our clients invest in meme stocks.

The primary reason is that the price of the meme stock is likely to be disconnected from the value of the company itself. This presents some high risks and uncertainties that could threaten a client’s long-term financial plan.

Beyond that, meme stocks are very concentrated positions in a single company. Our philosophy focuses on developing a diversified investment portfolio so that a single stock cannot substantially derail progress toward your goals. Instead of zeroing in on one particular stock, we use evidence- and academic-based analyses to give our clients exposure to many different asset classes through a mix of diversified mutual funds and ETFs. 

Another factor is that meme stock trading involves inherently short-term bets. Oftentimes, traders buy and sell meme stocks within a few days or weeks. We believe steady, long-term growth is what will help our clients achieve lifelong goals — like buying a home, saving for a child’s college education, or retiring.

Our approach isn’t designed to “time the market” or “beat the market.” We want to match the performance of different sectors of the market and, around the edges, tilt the performance to improve returns while also effectively managing risk.

In our view, achieving returns that approximate the market’s return at the lowest cost over an extended period is more effective and financially optimal than attempting to time the market in hopes of achieving large returns in short bursts.

For our clients, we remain focused on helping align their finances with their values to achieve financial peace of mind today — and tomorrow. 

The future of meme stocks

Meme stocks are still a new phenomenon relative to the stock market. Without much to go on, it’s difficult to know where they will go next or what the next meme stock will be (again, that’s part of the high risk and volatility that comes with meme stocks).

That said, it doesn’t appear that the concept of meme stocks is going away anytime soon. Since GameStop’s trailblazing moment, there have already been some stocks that have enjoyed the effects of meme stock fame, including AMC Entertainment (AMC), Virgin Galactic (SPCE), Clover Health, Blackberry (BB), and more.

A handful of mutual funds have also jumped on the bandwagon, and new ETFs with baskets of meme stocks have already been created. Some ETFs are even focused on predicting future meme stocks, by including stocks with high short interest and companies that are trending on social media. It’s likely that, at least in the short-term, more institutional investors and money managers will try to find creative ways to cut themselves a slice of the meme stock pie.

There’s also the possibility that the media and social attention given to meme stocks could present a short-term threat to traditional investment strategies. With meme stocks in the spotlight, people may get the idea that realizing huge gains in a short amount of time is the new normal. This creates unrealistic expectations and confidence bias, which could jeopardize some people’s long-term financial plans in a big way.

That said, meme stocks are unlikely to impact the actual performance and rates of return for most mutual funds and ETFs. The dangers of meme stocks are more closely tied to an individual’s financial habits and behavior than stock market performance.

When it comes to meme stocks, we find ourselves repeating the adage, “There’s no such thing as a free lunch.” While some may glamorize meme stocks as get-rich-quick opportunities, those approaches have not proven to be sustainable and present high risks to investors. 

We believe well-researched, evidence-based investment strategies will continue to win the day and help maximize your long-term return potential.