3 Minute Case Study: Don't go chasing hot stocks

Cathy Wood was the darling of wall street during the pandemic.

Her Ark innovation ETF invested in disruptive tech stocks that flew in value, some of them well over 300%, due to low interest rates and investor euphoria.

The euphoria has since faded, interest rates have gone up, and those stocks she invested in have come crashing down.

The key lesson in this story is to remember NOT to chase hot stocks.

Hot stocks are often overvalued, meaning they need they need to meet crazy growth targets that usually are not grounded in any sort of reality.

Miss these targets and the stocks will get burned.

Article Summary: “Cathie Wood’s Popular ARK Funds Are Sinking Fast” - Originally Posted by The Wall Street Journal

• Cathie Wood's ARK Investment Management is facing tough times, with investors withdrawing a massive $2.2 billion from its actively managed exchange-traded funds (ETFs) this year, surpassing total outflows in 2023.

• The company, which gained fame for its high-risk, high-reward bets on disruptive tech stocks, is seeing its asset base shrink significantly from a peak of $59 billion in 2021 to $11.1 billion.

• Despite earlier successes, persistent underperformance has led to a loss of investor confidence and a reevaluation of the role such aggressive investment strategies play in individual portfolios.

Educational Insights

The Risks of Trend-Based Investing: Chasing high returns through stocks that are "in trend" can lead to significant gains but involves substantial risk. When interest rates rise, as they have recently, the high-growth stocks typically favored by funds like ARK suffer due to increased costs and lower future earnings valuation.

Understanding Investor Behavior: The ARK scenario underscores how investor sentiment can shift from overwhelming support to broad disillusionment. Initial excitement about innovative companies can lead to rapid capital inflows, but patience can wear thin after extended periods of poor returns, prompting a mass exodus.

Diversification as a Defense: One key takeaway from ARK's struggles is the importance of diversification. Concentrating investments in a handful of sectors or themes increases vulnerability to sector-specific downturns. Broad diversification can mitigate such risks and stabilize investment returns over time.

Jargon Explained

ETF (Exchange-Traded Fund): A type of investment fund and exchange-traded product, i.e., they are traded on stock exchanges. ETFs hold assets such as stocks, commodities, or bonds and generally operate with an arbitrage mechanism designed to keep trading close to its net asset value, though deviations can occasionally occur.

Active Management: The use of a human fund manager to actively manage a fund's portfolio through investment decisions based on research, forecasts, and their own judgment and experience.

Interest Rates: The amount charged by lenders to borrowers for the use of money, expressed as a percentage of the principal, or original amount borrowed. High interest rates can reduce the present value of future company earnings, affecting high-growth stocks more severely.