Motley Fool Hidden Gems Investing - Stocks as FOMO Insurance

Episode Date: October 19, 2024

Nobody wants to miss out on the next big thing. But “the next big thing” may, in fact, be nothing more than a dud. How can investors find the happy medium FOMO and foresight?  Senior Fool Analyst Asit Sharma joins Ricky Mulvey for a conversation on the different reasons why investors buy stocks. They also discuss: What we can learn from King Charles’ portfolio.  The math of winners vs. losers. How to think about expected value. Tickers mentioned: SFT, PLTR, BTC, CRSP, RKLB, USHY Host: Ricky Mulvey Guest: Asit Sharma Producer: Mary Long Engineer: Tim Sparks, Austin Morgan Learn more about your ad choices. Visit megaphone.fm/adchoices

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I'm Mary Long, and that's Asit Sharma, a senior analyst here at The Motley Fool and a frequent guest on the show. My colleague, Ricky Moldy, caught up with Asit for a conversation on why we buy stocks and the different purposes that companies in your portfolio can serve. They also discuss how investors can take out FOMO insurance policies, why Asit likes to think of stocks as Play-Doh, and why the Venn diagram comparing investing with speculation has more overlap than you may initially think. So Asit, we recently had Alok Sama, who's the former chief financial officer of SoftBank on the show last weekend. And he has a book, it's called The Money Trap. And there was one idea that I wanted to use as a jumping off

point for our conversation. I brought it up before, but it's called... Actually, it's a word I can't use on a podcast, but for the purposes of this show, I will call it idiot insurance or FOMO insurance. You don't want to look like an idiot. So maybe you buy a little bit of something. In Alok's case, it's why he still owns stock in SoftBank after leaving the company. It's the reason why someone might just own a little bit of Bitcoin, which if you've owned it for the past year, it's worked out okay for you. But basically, the fear of not wanting to look like an idiot or not wanting to miss out on getting rich while we have these large scale societal shifts going on. Previously, it was crypto. Now, it's an artificial intelligence. And it's something that

I personally struggle with as an investor. I feel FOMO when I see something like Palantir's Rise. I've done a segment on it. I still don't know all the ins and outs of the company. I still don't quite understand it, if we're being honest. Look, you're a professional at this stock picking stuff, but do you feel FOMO? Well, of course, Ricky. I mean, fear of missing out represents something primordial in our psyches. All of us are going to experience it at some time or another if we're investors. We want to survive. Not only that, we want to prosper. That's hardwired into our genetics. So, the idea that over in this space close to me, something is there that will ensure my survival, prosperity, and I need to look at it.

If I don't look at that soon enough, I'm going to start to feel that fear of missing out. And I think this concept of idiot insurance is just fascinating. It goes back a few centuries, I think, where people who were selling businesses didn't want to give up all of it. Like, what if I sell it to this person and it just shoots up after I take my money? So, that retained interest, which you have such a great term for, idiot insurance, really is such a good jumping off point for our conversation about how markets can make us really bring our emotions to the fore and can actually dictate some of our actions for better

for worse. Primordial feelings can be a very good thing and very bad thing. Let's start with the negative side. We're seeing this now as there's a lot more investor interest in the market. That happens anytime you see a sustained rise in equity prices. We're seeing it with the big bank earnings we've talked about earlier this week. But when is the fear of missing out a negative for investors? Ricky, when it is hitting us and we fail to recognize that this is primarily something instinctual, it's an emotional reaction, it's a fear, that's when FOMO is most powerful and the most negative that it can be. It's when our brains don't articulate what's going on and we act without thinking. So I see a stock price going up. I see a business that's being hyped.

I don't know if it's a sure thing or the next money trap, but I'm just going to buy some because I have this fear that if I don't act, I will miss out on something big. And maybe if you rolled your eyes at the previous question, when is FOMO a bad thing? It's because I want to bring it to this question. We often hear about it in negative terms. It's something that's destructive for investors. You're chasing something on the way up and then it collapses. But can FOMO ever be a positive? Can we make this primordial instinct a positive? Or if it is a negative, how do you make FOMO into something positive? Well, FOMO can be very positive. After all, it's a signal. It's showing

us that a security is starting to take off and we have this, again, instinctual pull towards it. If you can treat that as something rational, if you can look at it from one remove, articulate it to yourself, then you may have some opportunity here. Remember, the market is constantly introducing many opportunities and there are many hype cycles. If you invest for long enough, you'll see more than one. So, this is one way to deal with that fear of missing out is to articulate to yourself, okay, there's something going on here that I probably should pay attention to, but I don't have to act on it. And in that vein, I say slowing down to speed up can be a way that you can turn FOMO into something positive. Maybe you sit down and take an hour out of your day instead of just rushing to buy something

that everyone is very excited about and do a little bit of research. In doing that, you might get a few indications that I should research this further or talk to some people or maybe pursue this in a more dedicated fashion. or I should just avoid this. This looks shaky. This looks smarmy. I don't need to waste any more time with this. Thirdly, I myself deal with this after I have explained to myself what's going on, what I'm feeling by buying what I call peanut shells positions. So, some people think of something small as being peanuts. I think even smaller sometimes. So, I will buy companies where I don't understand exactly what's going on. After doing a little bit of research, Ricky,

I'll take a very small position. And that, believe it or not, assuages some of my own fear of missing out. Because then if you have a small position, you can't hurt me. You're not going to take away my meals in retirement, if you will. And you feel you've participated. You don't feel like you're not part of the crowd. Now, running with the crowd is maybe not a virtue. But in the balance that you need as an investor, sometimes it's important to at least have a beat on what the crowd is doing. So let's bring it back to the idea of FOMO insurance then. One way of dealing with it, you're a little afraid of missing out on these exciting new technologies. So you make

a smaller speculative bet. This is a time, Asit, to let your freak flag fly. I'll give you one that I have, and that's with CRISPR. I have looked into CRISPR. I really admire it. I'm optimistic about the idea of using gene editing to completely cure a lot of maladies. I mean, For example, CRISPR technology just has a cure for sickle cell, which is incredible. I think it's undercovered even what they're doing with this technology. I own the stock in CRISPR, and I've also lost money on other biotechs that use CRISPR technology. There's going to be winners and losers, and I don't have a biology degree. It's something that I am not a technical expert in, even though I believe in the general trend.

Do you have any FOMO insurance policies that you own? I've got a number of them, Ricky. I have this thing called a seven-year stock. So we always talk about holding a stock for five years. But there are some companies which aren't really generating much revenue at all, but they're in these incipient industries, often high tech, where if the business can survive the first couple of years and gets the capital it needs, it has a market in which it can potentially expand into.

And that market itself is starting to come together. So, these are speculations. I mean, these are small bets, if you will, on things like air taxis, quantum computing, server energy management, semiconductor intellectual property, and the like. So, I sort of believe in having these insurance policies, but there's another element to it for me as well. It's a learning experience. These are industries that I think may grow in the future. So I want to get in on the learning piece

now and be aware of them. So it's not just about the FOMO. It's about looking at a part of the world that I think might expand and might hold some value for me. It's a bit of both. I want to get to a broader discussion. We've done these FOMO insurance policies, but I think there's a way of buying one that's much more boring. And that is with plain vanilla index funds. If you owned a Standard & Poor's 500 index fund over the past five to 10 years, you've benefited personally from the incredible rise of a company like NVIDIA. And while we often talk about the benefits of stock picking, where you can create your own collection of hopefully wonderful companies, do you personally use index funds for your own money, even outside of your

employer's 401k? Sure, I do. Just a few. I have a handful of ETFs that I buy, and I think they are good for many investors. I would say like long-term, I'm trying to build up my ETF holdings to be about 30% of my portfolio. So I'm focusing on them a little more than I used to. And then I think I'm trying to basically use more reason for owning stocks. And I know that sounds almost simplistic, but I think it's a constant thing you have to do as an investor. Because I use index funds, especially for areas that I don't want to think about. So for something like high yield bonds. So there's one I own, it's USHY. It's done by iShares. The fund has a trailing 12-month yield of a little less than 7%. So essentially, the deal I've made with this index

fund is that I have a pretty capped return on what it will ever return me. It's not going to do something like an incredibly innovative company. This is debt. But I think of it in terms of this reason. I have these little soldiers that I've now sent out and their job is to collect a little bit of money for me forever. The trade-off I'm making is that I have a capped return and I'm letting those soldiers do the work that I don't want to do, which is buy bonds. I don't want to analyze debt securities. I want someone else to do that. And I'm willing to pay a little bit in terms of a management fee. Do you think of index funds like that? Just go take care of something that I don't even want to think about. I think so. And maybe even I think about it as things

that I want to take care of, but I believe are just beyond my capabilities. I'll give you an example. I often advocate for investors who are interested in companies like NVIDIA and AMD and Broadcom to buy the SOXX. This is an index fund. It's an ETF, which has not a lot, about 30 positions of leading semiconductor companies. As much as I study this space, Ricky, the world changes almost more quickly than you can keep up with it. And what's a great way for me to send out little soldiers, if you will, and make sure that I don't miss out and I reap the return? Because I can be wrong. As many companies as I think may appreciate in the future because of their technology and the markets, yeah, I could be way off. So, one way that I make that task a

little easier is to invest in this ETF. And I have a few others, I think as many of those listening do that try to track the broader market or a few themes in the market for that very reason. So that's the reasoning for buying an ETF. In addition to more, the reason is I'm putting some money away so I can have even more when I retire, hopefully. Let's go back to stocks then, because we're doing something for the Motley Fool here. Why buy a stock? What's your reason for owning dozens and dozens of individual companies? Well, Ricky, I think many of these companies that I own are going to remain Play-Doh. and a few of them are going to become claymation or stop motion films.

And so, of course, I'm referring to the Pareto principle here, which is something that foolish investors know about. It's the math behind the proposition that if you own, let's say, 100 stocks, maybe 20 or fewer will drive 80% or more of your returns. So, this is sort of quasi-engineering principle. It's used in a lot of different industries, but it really relies on two things. One, that inputs and outputs are semi-random. You can be a really efficiently informed investor, but you can't control what happens with the businesses you buy or the people who run those businesses. So it relies on that. And also just the principle of diversification. If you concentrate your bets on one or two ideas and you're wrong, your capital goes to zero. If

you can spread those bets out, you have a better chance, one, of maintaining your capital, but two, return probabilistically, that payoff should increase. So, I like that principle. And I should say here, I do have a nostalgia for blue Play-Doh in a yellow can. But I want to think or I'd love to think that I was part of the creation of a fantastic Mr. Fox, one or two of those before my investing career is over. And of course, what I'm referring to here is the fact that claymation, films that are made out of clay figures, take a long time to make. You have to move a little bit of clay and then you take one frame of the film. You keep doing this process.

So, this is akin to buying a company, holding it for 5 or 7 or 10 or 15 or 20 years, buying more on the way up as you learn about that business and participating in this slow act of making something great. There's a learning process, there's a voyage of discovery in that that I want to participate in and to increase my wealth along the way. And you're also playing the game on your terms. You're deciding your own holding period, you're deciding the companies you own, and this gives you as an individual investor, a lot of advantages over institutional folks who have greater resources, probably greater wealth, but also a lot more parameters for how they're

allowed to behave. As we stay on this theme of reason, one of the reasons I wanted to do this show is sort of run this take by you. Because I've been changing how I think about stocks as ownership in a company. And this may sound a little radical, but you have a claim to the profits of a company, but I'm starting to think of these companies almost more as wealth managers. So I'm wondering if this is a different question. Do I want to own this company versus do I want this company to take care of my money for three to five years? Do you think those are different questions, the same question, or is it even meaningful to make a difference here? I think they're different questions. Do I want to own this company is sort of the first point

you laid out. Do I want to claim on the future profits? Do I want this company to take care of my money for three to five years? I think it's a different question. It goes beyond what the stock price is going to do. And it posits that I'm entrusting my money to people who are going to make decisions, who are going to manage capital, use the assets, pay off the liabilities, get a revenue stream going, have some expenses underneath that. It's a much more complex trust mechanism, I think, when you start thinking in those terms. And I think it's a philosophical question, Ricky. So, the loss averse or annuity-seeking investor, he or she thinks in terms of stewardship. Okay, so I'm giving you my money, you're going to

preserve it, maybe give me a dividend. The really speculative investor thinks in terms of venture funding, like I'm going to give you some risk capital and I want that payoff to be big and I'm willing to take some volatility. In the meantime, most investors fall in between these two extremes when we think of handing over our money to another company. So, we could stick on this pretty fascinating question for the rest of the way, but I know you've got other things to talk about. We could stay on it for a little bit because it has changed how I think about things. And when we think of a wealth manager, we often do think of something incredibly conservative, but realistically, so I own some shares of Meta. I'm not really the owner of the

company. Mark Zuckerberg is. And what I've done instead is said, here's some of my paycheck. I want to see what you can do to take care of it for the next number of years while you own the super voting shares of what's going on. I own a company and I talked about it earlier this week, Charles Schwab. That to me is something that's more foundational. I'm giving you my money, not because that I think I'm the owner of the 10 trillion in assets that you have, but I think you're going to be around when I retire. Or at least I hope you are. There's really bad things that are going to happen if something like Charles Schwab is not around. And then for something like Rocket Lab, they're sending rockets into space. They got to orbit

before Jeff Bezos' company did with all of the tremendous resource that Blue Origin has. Now, granted, Rocket Lab has a little bit of a lead, but for me, that's more of a, hey, here's a nickel. Let's see what you can do with it. So even though I've got my different reasons for these managers, how many managers do you think I really need? You know, if you're the person who's looking for stewardship, you just need a few solid managers. if an investor is in the business of increasing his or her wealth, that investor, they need many more specialist managers. And again, most of us are going to fall within this spectrum.

Ricky, I think you need a little bit of both. And I think the examples you laid out are pretty sound. It's evidence of judicious allocation of your capital. There's a nice thought process behind it, it reminds me of King Charles' portfolio. King Charles owns the Duchy of Cornwall. It's a $1.5 billion business, but nestled in that are all kinds of businesses. There's farmland, there's commercial real estate, there are operating businesses. So, if you look at how the royal family has structured their wealth, it is something that has marginal risk. It's got a solid core. And they, of course, I mean, King Charles is going out and around being king. So he has people managing his wealth for him. But yours reminds me of that

sort of approach. So to sort of solidify the reasoning I've been using, I have four right now. And you can add to them if you like, or you can subtract even. One is that I'm along for the ride with you as a wealth manager with owners who have skin in the game. I think of that with a lot of small cap companies. The second is that I don't think your firm is going to shut down when I retire. I think about that with a company like Home Depot. I'm going to have questions about home improvement for a long time. Even Spotify, among a lot of people, myself included, I don't see myself ditching Spotify for another platform when it knows so much about me. The longer I stay with it, the longer I stay with it. The third one, which is related, is that you operate the world.

Charles Schwab previously mentioned also a company like Prologis, which owns a lot of the warehouses that Amazon uses. The world needs this company to operate. And then the fourth one is here's a nickel. Let's see what you can do with it. That's your crispers, your rocket lobs, that sort of thing. Anything you'd add here, anything belong in those reasoning questions for these ownership stakes I have, but really the wealth managers I've been using for my money. Yeah, this is a pretty complete metaphor. Maybe the only one I'd add is here's a quarter, keep doing what you're doing. So, think of companies that may fly a little bit under the radar. They're high return on invested capital companies. They don't make a lot of

noise one way or another. So, they're sort of between that along for the ride, Winmart companies and the ones that aren't going to shut down when you retire like the Home Depots. They may be mid-cap companies with just a solid track record of 10% to 15% annualized returns in their business and therefore their stock price in many cases. But other than that, I like it. And then in your job as an analyst, or when you're putting money into a stock for your own personal portfolio, what sort of reasoning questions are you using to decide whether you're buying it or what kind of allocation you're taking? Yeah, so just a couple of simple questions that I typically ask is, number one, how is

this purchase affecting the current composition of my portfolio? So I like to think of my holdings as this holistic whole. I know in reality, I probably have positions that are way more correlated than they should be. I've got concentrations, blind spots, risks I don't foresee. But in general, I want to know if I'm adding McDonald's to my portfolio, what does it say about the rest of my portfolio? What's its contribution?

I love dividend companies. I love growth companies, tech companies, consumer goods. So that's one question. And then what's my guess regarding the probable outcome? You should have an end goal in mind. And I think, Ricky, you spoke to this earlier. With your nickel stocks, you should have an expectation for every company of what you think it can return to you on an annualized basis. And in most cases, we're just thinking of the stock price. But if it's a dividend company, you can think in terms of total return. That helps me understand how I might position overtime in terms of size relative to the rest of the portfolio. Yeah. And some of my larger investing mistakes have not been buying companies. It's actually been selling ones. I'm sure you sometimes feel the itch though. You're ready to get out of a

position. It doesn't feel good for whatever reason, whether it's the good scenario where it's grown to be too much of your portfolio. Maybe you have questions about the future direction of the company that you didn't originally have when you bought it in the first place. So what reasoning questions do you use when you start feeling that itch, Asit? Honestly, Ricky, I've changed my strategy over the last several years. I start my position size as small and I typically don't sell anymore. I've had some wonderful conversations with some really smart fools, our quant investors at The Motley Fool and some others, our CEO Tom Gardner as well, who have demonstrated to me the math of winners versus losers. A loser on your portfolio

because it's a small position theoretically, if you haven't over-indexed on a certain name, going to zero really doesn't matter much mathematically in the long term if you've got your fair share of winners. So, I just keep companies on my personal scorecard. I learn from them, I study my mistakes, and I actually don't sell. Sometimes I've sold in the past only to see a company that was on the ropes down for the count have a resurgence. And in truth, if you have a portfolio of even 25 or 30 companies, you can't follow each one individually that closely, even if you're in the business of doing this full time as I am. So that's my current strategy. And it's actually working out for me, I think.

Never sell. As we end, we've done the reasoning, sort of the English, let's use the English class side of your brain. We're going to use, go now to sort of the statistics, the probability stuff, because a lot of statistically minded people like to use expected value for the decisions. So the poker example is that if you have a pair of cards, you're going to hit a third card in your pair or trips on the flop when three cards arrive about one in every eight times. That's a lot of numbers, but basically you're like, how can my hand improve if you're playing a game of poker? There's ways of doing that when you're buying stocks. I've tried to simplify this, which is, I think there's a decent chance you'll turn it around, maybe 50-50. Or I think that

there's a very good chance, let's say 80% to 90% that this stock will be worth more when I retire in a few decades, even if it's not just doubling every five to 10 years. So how do you think about expected value in terms of investing in stock purchases? Well, let's take your examples first, Ricky. These are heuristic questions that you are asking, which demonstrate, if we stick with the poker analogy, your edge on the house. So you're a reasonably experienced investor. You have the ability to analyze companies. Maybe your success rate is 60%, 70%, I don't know, which would be great, right? So, most even talented investors have an edge over other investors that's marginal. I mean, the best investors maybe are right 55%, 60% of the time. It's the position sizing

and the focus on the winners that separates them from us. So, yes, I mean, in that sense, I do think about expected value. Again, I was talking about looking at my portfolios as holistic things. So I'm always thinking in terms of my capital, my particular edge, my ability to remain in the game after several hands and price variation. So price variation influences like when you buy, how much you buy. So initially, again, I start small and I start adding money as I go along, as I learn about a business more. If it's going up, I've learned from David Gardner and other fools. It's not that big a deal. You can buy some more. It's okay. And sometimes I'm buying on the way down because I think I understand the business. But the thing that I always wanted

to keep an eye on is my capital, my ability to stay in the game, the duration of it. And I wanted to just take a second here to relate that to speculation because we were talking about speculating at the beginning. Actually, investing and speculation are pretty closely related. I'll stop here and get your thoughts on that before i go any further yeah i think that there's a version of investing where it's it's the farthest thing from speculation or it's positioned is the farthest thing from speculation it's it's not as far as many in uh working in a place with marble floors would like it to believe there is a key difference though in in in between investing and gambling though so gambling is an all or nothing bet on a defined outcome at a defined end date where real

investing, you're making up the rules essentially as you go along. You get to choose the length of how long you have money in the thing you believe in, which makes it different than a gambling type bet. In my opinion, even if you can, you're doing things in a more speculative fashion, if you will. Yeah, I love that. And speculation is the close cousin of gambling. While it doesn't have a defined end date, it does tend to have a much shorter timeframe wrapped around it. Most people speculate going in very quickly and trying to get out very quickly. Traders do this. People who are investing on a whim or on a piece of advice from someone are similar in this regard. But the similarity between a seasoned investor, a speculator, and a gambler is pretty interesting.

Each of them allows or wants enough capital to have enough capital in the game to let that edge on the house manifest, but with respect for that balance between risk and return. So there's a famous speculator, Victor Niederhofer, who made and lost several fortunes. He's got this amazing book called The Education of a Speculator, which was published in the 1990s. He stated it this way, the speculator wants to bet lightly enough relative to his capital to fend off gambler's ruin, but heavily enough to make his desired rate of return. Now, I'm going somewhere with this. We're not trying to turn this from an investing conversation to a gambling conversation, but consider the person who is investing pretty regularly from his or her or their paycheck.

It's non-speculative investing. They're spreading their little parts of their paychecks over a number of promising companies for a long duration. We are always thinking in terms of the present value of future cash flows, Ricky. So, if someone asks you what's a stock worth and you give the answer, you're actually performing a present value of future cash flows calculation. What you're really saying is, oh, I think they're going to make X money in the future. I discount that back to the present value. And I think it's worth X divided by all the shares outstanding. This is the price. Now, none of us, few of us really do that math in our heads, But intuitively, this is the process that's going on. When you try to name the price of a company, you're thinking about what it's going to be worth in the future in today's dollars. But investors don't talk enough about the future value of an annuity.

So, the value of part of your paycheck invested today and two weeks later and two weeks later over a career of investing, that is a really good probabilistic bet. Those odds favor you. I'm going to stop here. I have one more point to make, but I want to get your reaction on that. I think you've made a great point and I'm afraid to stop your rhythm here, Asit. All right. So, let me relate this back to you, Ricky.

So, if you're that type of investor who basically has this very solid game plan, you're focused on the future value of your annuity investments across so many great companies, there's space there to play, to sprinkle in some nickel bets, as you call them. And you want to find some strong asymmetric ideas where that payoff is worth the inconsequential capital you're putting in. If you're putting in a nickel, you might want a quarter in return over time, or maybe even a dollar. So, you're going to try to gravitate towards strong ideas that have a fair amount of risk associated with them. Now, this is the opposite of the speculator who is new to the game, who's like, I'm going to take my lump sum and bet it all on CRISPR, because I think CRISPR can go to the moon.

CRISPR might go to the moon, but it might sit in a puddle. And by the way, I too have been fascinated with CRISPR. I saw the joint venture it had with Vertex Pharmaceuticals. It's a very interesting company. Anyway, all this to say that the worlds of investing and speculation, while on the surface they seem far apart, each can benefit from application of the principles of the other. And this goes back to why we started talking in the first place. Sometimes thinking about FOMO just feels a little like, should I even be worrying about that? I mean, that's not the kind of rational investing that makes money over the long term, is it? But it is. You have to own your feelings. You have to acknowledge them, understand why they're driving you to certain actions, be able to make good decisions and deal with your emotions. And sometimes that involves scratching the investing itch, as David Gardner likes to say. But I'm sure we could talk much more about the relationship between these two. But you probably want to wrap up this long conversation. We can wrap up here. We can talk about how we deal with what could be destructive feelings in non-harmful ways.

There are conversations outside of investing for that. Asit Sharma, appreciate you being here. Thank you for your time and your insight. Thanks a lot for having me, Ricky. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Mary Long. Thanks for listening. We'll see you tomorrow.