A group of small investors who frequented an internet chat board produced mammoth gains in GameStop stock in recent days, while saddling big Wall Street players with elephantine losses. In the fallout, the popular stock-trading app Robinhood and several hedge funds are reeling, even as some of the GameStop investors have moved on to other targets — most recently, the market for silver.
Is this something that should concern retirement savers? Probably not. If you’re investing for retirement, you should be looking at the long term, not next Friday, for your gains. You also shouldn’t be cavorting with individual stocks, especially those of small, shaky companies. Stick with well-diversified, low-cost mutual funds, which don’t pull these kinds of shenanigans, and leave short-term gambling to people with money to burn.
What just happened here?
GameStop is a retail store that lets people buy or rent video games and the various things you need to play them, such as controllers, headsets and memory cards. Since gamers tend to download their games these days and order their gaming accessories online, the company lost money in 2020 and announced plans last year to close 450 stores. Not surprisingly, the stock (ticker symbol GME) has languished, selling for as little as $2.57 a share last April. GameStop’s lousy stock performance prompted big Wall Street investors to make massive bets that the company’s price would continue to fall. In Wall Street parlance, they shorted the stock.
When you short a stock, you borrow shares from someone else, sell them, and hope to buy them back at a lower price when it comes time to return them. If you sold borrowed shares at $10 a share and repurchased them at $7 a share, you’d have a $3 profit per share (minus trading costs including the small fee you paid to borrow the stock).
The catch: Sooner or later you have to close out those positions. If you’re shorting the stock, you have to buy enough shares to repay the shares you borrowed. Shorting is all fun and games when the stock falls. When the price rises, however, panic can set in, particularly if there are many huge bets on the stock falling.
And that was the problem with GameStop. Big Wall Street players loved to short the stock. But when it came time to close out their short bets, they had to buy back the stock they borrowed at ever-higher prices. GameStop’s stock peaked at an eye-watering $483 a share on Jan. 28.
On the other side of the bet were small investors who saw relatively modest investments soar in value. As more and more people piled in to scoop up shares, GameStop’s price rose higher and higher. Robinhood, a free trading app that can be downloaded to a smartphone, helped fuel the buying frenzy by allowing small investors to trade stocks — and even fractions of stock shares — with no commissions. Jaydyn Carr, a 10-year-old whose mother gave him 10 shares of GameStop that cost her $60, sold the stock for a little less than $3,200. The stock’s three largest holders reportedly made more than $2 billion in the past few weeks.
Robinhood, facing financial pressure due to the unprecedented volume of trading occurring through its app, temporarily limited trading in GameStop and a few other stocks caught up in the excitement, provoking howls of outrage from those who use the app — nearly as loud as the wailing of big Wall Street investors who lost money. “For investors, it was a lesson in social media and the combined impact of smaller investors (and social trends), in what some, on the wrong side of the trade, called mob rule, flash trades and manipulation,” Howard Silverblatt, senior index analyst at S&P Dow Jones Indices, wrote to clients.
Save 25% when you join AARP and enroll in Automatic Renewal for first year. Get instant access to discounts, programs, services, and the information you need to benefit every area of your life.
Lessons for retirement savers
For the average retirement investor, the GameStop storm has little impact. Most people can’t buy into the hedge funds that got slammed by betting against GameStop stock. You generally need a net worth of $1 million (excluding your home), or an annual income over $200,000 (or $300,000 jointly with a spouse) for the previous two years, just to qualify to invest in a hedge fund.
Some pension funds that invest heavily in hedge funds could have gotten dinged. But it would be highly unusual for a pension fund to have a large portion of its assets in any one hedge fund. Pension funds are required to be diversified and minimize the risk of large losses.
And individual retirement investors probably read about it on the news, not in their 401(k) balances. “A retirement saver that participates in a 401(k) shouldn’t have anything to worry about because the available fund options aren’t likely exposed to a short-selling strategy like GameStop,” Mark Bass, a financial planner in Lubbock, Texas, said in an e-mail. The SEC restricts short-selling in most mutual funds.
The typical retirement investor buys mutual funds, and most mutual funds don’t even own the stocks that were part of the recent wild swings — or don’t own enough to make a difference. Forty-five percent of all 401(k) assets are invested in mutual funds, and another 31 percent are in collective investment trusts, pooled investments similar to mutual funds, according to Morningstar. When you own a fund with hundreds of different stocks, all in different industries, the gyrations of one or two small holdings doesn’t make much of a difference. For example, Vanguard Total Stock Market Index fund, the largest U.S. stock mutual fund, owns 2.1 percent of all GameStop shares, according to Morningstar. That rounds to less than 0.01 percent of the $1 trillion fund’s total assets.
“If someone has a self-directed IRA that allows someone to gamble — excuse me, invest — in GameStop, then that’s a different matter,” says Bass.
But if you have a typical 401(k) portfolio composed of mutual funds, don’t worry, Harold Evensky, founder of Evensky & Katz/Foldes Financial in Coral Gables, Florida, said in an e-mail. “Just enjoy the entertainment watching the crazies on both ends of the GameStop transactions going nuts and getting well-deserved ulcers,” he says.
And retirement investors are in it for the long haul, which means, generally, you’re not hoping to invest in a stock on Monday morning and double your money by lunch on Tuesday. After all, a stock that has the chance of doubling overnight also has the chance of being slashed in half overnight. Thanks to the remorseless mathematics of losses, a person in or near retirement is less likely to be able to recoup a big loss than a younger investor. After all, if you take a 50 percent loss, you need a 100 percent gain just to get even. And as of Feb. 3, GameStop stock had tumbled to $92.41, an 81 percent loss from the Jan. 28 high.
What’s the biggest takeaway for retirement investors? Stay diversified to reduce your risk of catastrophic losses, including diversification outside of the market. Take time to think about your goals and how you’ll achieve them. “If you have a complete plan,” says Pete Cymbalak, investment advisor with Empowered Financial Management in Middleton, Wisconsin, “stick to that plan. If you don’t get distracted by the shiny objects and don’t get fearful from the black clouds, you’re going to be OK.”
John Waggoner covers all things financial for AARP, from budgeting and taxes to retirement planning and Social Security. Previously he was a reporter for Kiplinger’s Personal Finance and USA Today and has written books on investing and the 1998 financial crisis. Waggoner’s USA Today investing column ran in dozens of newspapers for 25 years.