The new movie “Dumb Money” dramatizes the true story of an unlikely messiah named Roaring Kitty who decides to sink his life savings into shares of the video-game seller GameStop and then praise the stock to his fans. So many people buy GameStop shares that the company’s valuation soars, crushing the positions of professional hedge funds that had bet against it. Thus, a band of lovable misfits triumphs over the Wall Street fat cats.
Much as we enjoyed the movie, we are economists, not movie critics. And as practitioners of the dismal science, we worry that some viewers will continue to be inspired to copy the heroes’ investment strategies, which is about as smart as driving home at 100 miles per hour after seeing “The Fast and the Furious.”
You can see our worry in the movie’s title: “Dumb Money.” That’s Wall Street parlance for unsophisticated individual investors who make mistakes that can be exploited. Is it nice to call the actions of everyday Joe investors dumb? No. Is it fair? Well … yes.
We aren’t literally calling retail investors dumb. What we are saying is that retail investors are smart people who unfortunately behave in dumb, self-destructive ways. Their actions reflect overconfidence, financial ignorance and a wealth-reducing love of gambling. Even smart people like Sir Isaac Newton can make dumb investment decisions (he lost money in the South Sea bubble).
And in celebrating an unintelligent investment strategy in a moment when the stock market was reaching historic heights of stupidity, “Dumb Money” raises an important question: Are American financial markets getting dumber over time? Or was this just a momentary lapse?
We did see a prior peak of stock market dumbness in the 1999-2000 tech stock bubble, when many retail investors made the mistake of being wildly overoptimistic about technology stocks. One of us, Owen Lamont, has even co-written (with Andrea Frazzini) an academic paper titled, you guessed it, “Dumb Money,” describing self-destructive investor behavior during this period. But compared to the events of the GameStop story, that crazy optimism seems almost rational, since it at least involved a correct thesis (that the internet would eventually produce some profitable companies), however stupidly applied.
After the tech bubble burst a year or so later, U.S. stock markets were less obviously dumb until the Covid-19 lockdowns spurred a tsunami of retail investing, as enormous numbers of people were suddenly stuck at home with nothing to do and, importantly, nothing to bet on. Casinos were closed and professional sports were on hold. Meanwhile, brokers like Robinhood were offering the option of trading stocks commission-free.
The gambling impulse was also goosed by stimulus checks and social media platforms like Reddit and YouTube. Money flowed to “meme stocks,” shares of oftentimes struggling companies that somehow caught the popular imagination owing to nostalgia or the desire to root for the underdog. This brings us to GameStop, a meme stock whose rise at the start of 2021 — despite the company’s dismal business outlook — was really also an expression of populist anger. Ordinary Americans wanted to bet on the home team (an army of individual investors) against that other team (sinister billionaires betting against America).
Since GameStop, a suspiciously high number of other dumb things have occurred recently. Just this year, we’ve seen bizarre price fluctuations of meme stocks that are in or approaching bankruptcy and in foreign companies listing in the United States. One possible culprit for this wave of global dumbening is social media, which played a big role in GameStop by facilitating investor herding.
Should we throw up our hands and conclude that the whole stock market is crazy? No. These crazy incidents still remain confined to only a few stocks. Stock prices usually revert to fundamental value, although it may take years. When this happens, retail investors who overpaid and held on too long get hurt.
Retail investors have a well-established track record of destroying their own wealth. Studies have shown that individual traders somehow have the opposite of skill — they manage to do worse than they would by picking stocks at random.
Why? Investing is hard, and there is a lot of competition. There are thousands of actively managed mutual funds. Do you think the average golfer would have a chance against Tiger Woods in his prime?
The ineptitude of individual investors is not for lack of trying. In fact, the harder that individual investors try (in the sense of trading more often), the more they lose. For example, the professors Brad Barber and Terrance Odean found that women investors did better than men. Why? Because men traded more. (They titled their paper “Boys Will Be Boys.”) So the conclusion from this finding is not (necessarily) that men are dumber. They are just more aggressively and overconfidently manifesting their dumbness. Perhaps this idea will resonate with some readers.
The wealth-destroying powers of retail investors have been demonstrated many times: in stocks, mutual funds and options markets; in different countries and in different time periods. The evidence from Taiwan, which has excellent data on stock market trading, is particularly striking. Mr. Barber and Mr. Odean, together with their co-authors Yi-Tsung Lee and Yu-Jane Liu, have shown that individual investors underperform other investors by nearly 4 percent per year and that these losses are equivalent to about 2 percent of Taiwan’s G.D.P.
If retail investors are the dumb money, who’s the smart money? The answer includes skeptics who can spot a company’s shortcomings and express their views by either selling their shares or betting that share prices will fall in a practice called short selling.
Although “Dumb Money” depicts professional hedge fund investors as heartless villains who treat a pet pig better than their housekeepers, it would be wrong for movie audiences to think that selling short is inherently bad. As we saw in the movie “The Big Short,” which depicts a band of misfit short sellers spotting major problems in the U.S. financial system before its near collapse in 2008, these investors can also be lovable — even heroes. (Full disclosure: We may be biased about “The Big Short” because one of us had a small part in the movie, while the other is jealous about that fact.)
We certainly hope that over time, widespread meme stock investing will go the way of toilet paper hoarding and people will go back to rooting for the Red Sox versus the Yankees (or vice versa) instead of Roaring Kitty versus hedge funds. We hope that citizens concerned about inequality will express themselves in the voting booth, not in the stock market. And we hope that retail investors confine their gambling to small stakes, like buying lottery tickets or placing wagers on their favorite teams.
Ask any finance professor and you’ll get the same boring answer: The best way for most people to invest in the long term is to hold a diversified portfolio of stocks. Admittedly, a movie about a bunch of ordinary people gradually building wealth through prudent financial decisions would be the world’s most boring movie. Boring, but also not dumb.
Owen A. Lamont is a former professor of finance at the Yale School of Management. Richard H. Thaler is a professor of economics and behavioral science at the Booth School of Business at the University of Chicago.