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Is the Trend Your Friend? Investing Fads to Avoid

Slide 1: Fads are appealing, but risky
Investing fads were behind some spectacular market collapses: the silver meltdown of 1980, the dot-com blowout in 2000, the real estate bust in 2007. In fact, asset bubbles have whipsawed investors at least as far back as the 17th century, when “tulip mania” bankrupted many a Dutch speculator. 
 
Yes, some investors make money when fads take off, but far more are likely to get burned. “The selloff is so swift that you usually can’t get out in time,” says Brad Sorensen, director of market and sector analysis at the Schwab Center for Financial Research. Here we’ll examine why investing in a trendy company can seem irresistible—and how you can stay in control in the face of a supposedly sure thing. 
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Slide 2: The neurobiology behind the fad response
Even after memorable flameouts, investors still chase fad stocks. The reason for this behavior may run as deep as human biology. Scientists theorize that upward-trending stocks, by inducing anticipation of a high payoff, may increase activity in the nucleus accumbens, a dopamine-rich area of the brain. Increased dopamine leads to excitement. This emotional arousal, when combined with other factors such as herd mentality and overconfidence, may lead to increased susceptibility to impulsive behavior.
 
Fortunately, it’s possible to keep calm and stick to your investing plan by focusing on the facts and fundamentals of any given sector or company. 
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Slide 3: Four trends that might be too hot

Stock niches are constantly changing, and some are more prone to overheating than others. According to Brad, fads are like buses: “A new one comes along every few minutes.” Some trends to watch out for today include biotech, “healthy living” companies, social networks and fast casual dining. 

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Slide 4: Biotech: more promise than profit

Like the dot-coms before them, many biotech companies have seen their share prices soar, based more on promise than on actual profits. That’s not to say many companies won’t succeed. “Several companies have made critical breakthroughs in treating cancer and other serious diseases,” Brad notes. “But picking the long-term winners out of this packed field is more of a guessing game than a sure thing.” 

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Slide 5: Let healthy living trends cool off

Indoor cycling studios, “wearable” fitness trackers and gluten-free anything are hot right now. But the diet and fitness industry is notorious for its fads. Remember meal-replacement shakes and the South Beach craze? Yes, yoga has been around for thousands of years, and people who suffer from celiac disease will always have to avoid gluten. “Most trends, though, will not stand the test of time,” Brad warns. 

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Slide 6: When networks overload

Social networking has grown exponentially in the high-tech market, with new apps debuting almost every day to help people connect. But be wary of the plethora of recent spinoffs trying to compete with the core players, Brad says. Many new companies depend on advertising dollars for revenue, and the competition is fierce. “Advertisers are focusing more on tracking ad success on these networks, not just relying on user count.” 

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Slide 7: Fast casual dining: overcooked?

Offering a wider range of cuisines—and often higher-quality ingredients than traditional fast food restaurants—fast casual restaurant companies have seen rapid growth in recent years: a 550% increase in sales since 1999, according to Euromonitor, a research firm. Fast casual connoisseurs may be tempted to believe that their palates will decide who will come out ahead. “But you can’t just pick stocks with your taste buds,” Brad says. Restaurants, even big chains, face strong headwinds from diners who may be chasing a different food fad next year.

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Slide 8: Watch for the warning signs
So what does a fad look like? Investors should watch for these warning signs:
  • Fast growth, but no earnings. A company may be popular, but not profitable.
  • A spike in the stock price. If the stock already had a big run, check its current valuation against historic price-to-earnings ratios. If it’s trading well above historic ranges, a big selloff may be coming.
  • Overemphasis on clever marketing. Some companies garner interest with a catchy jingle or lovable mascot. But a smart business plan is what’s important. Keep your eye on company fundamentals, Brad says.
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Slide 9: What you can do next
If you’re going to invest in the latest craze, you could set aside a certain portion of your portfolio—but make sure your eyes are wide open and your long-term investments aren’t included in the mix. Talk to a Schwab Financial Consultant or visit a branch near you
 
“Investing in a fad isn’t investing—it’s speculating. So understand the risks, and only use money you are willing to lose,” Brad cautions. “You may have found the next big thing, but remember, there’s a huge wasteland out there filled with duds.”
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Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. 

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. 

All corporate names and market data shown above are for illustrative purposes only and are not a recommendation, offer to sell, or a solicitation of an offer to buy any security. Supporting documentation for any claims or statistical information is available upon request.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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