Investing with your gut - MoneySense

Investing with your gut

Tips for investors who have play money and can stomach losing it all

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Most Canadians are boring investors; they sock their money away in plain vanilla mutual funds or Exchange Traded Funds (ETFs) inside of Registered Retirement Savings Plans (RRSPs) or Tax Free Savings Accounts (TFSAs). And that’s exactly how it should be—saving for retirement isn’t about blowing the light out with a hot stock.

Some people, though, have saved up enough money that spending $20,000 on an outside-of-the-box investment won’t ruin their futures, even if it all disappears. The point is not to squander the money, but to cash in on outsized returns that don’t come around every day.

Think about consequences

So, what’s the best way to put your “play money” to work? The first step is to think about how risky you want to be, says Allan Small, a senior investment advisor at HollisWealth. “It may sound silly when talking about ‘play money’, but understand the meaning of high risk,” he says.

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In other words, what might be risky for one person may not be risky enough for another. For instance, owning a small-cap green energy stock that’s barely making money but could one day hit the jackpot is the kind of unusual investment some would like to own. For others, it’s a troubled asset in a more traditional sector, like Bank of America during the great recession. Something with big upside in the event of a turnaround.

Small has a few ideas that he can recommend to certain clients, but people often have some notion of what they want to buy. “Usually it’s something they’ve seen on TV or that their neighbour told them about,” he says. “That happens quite a bit.”

Find a good story

While some insist on buying the most popular stock they’ve heard about, Small says people should think more carefully about what they want to own. For instance, he prefers owning companies, even high-risk high-reward ones, that are making money, like distressed banks or insurance companies.

Of course, a lot of hot businesses aren’t turning a profit and their stocks still soar. Think Facebook or Amazon when they first came to market. Why the gains? Small explains it’s because they had a good story, which can be more important than valuations or profits.

The key to investing with play money is to choose something where you can say, with some degree of confidence, that the product or technology is poised to change its industry. Maybe a tech stock is disrupting a staid sector or a biotechnology business is working on a cure for cancer. If you can say those things, then buy in. If not, then stay away.

“Why would you go into a company that’s hot? Because you think the story around the future of the company is positive and you’re willing to pay a premium for that name,” says Small.

Choosing ETFs or stocks

Once you’ve determined a thesis and chosen an area to invest, there are two main ways to play that idea: through individual stocks or ETFs. Ask yourself, is the sector, as a whole, promising, or do you have your sights set on a particular operation?

The biotech sector, which has been intense for years and continues to climb, is a good example. There are several companies testing new drugs that could have an enormous impact on the way doctors treat cancer and Alzheimer’s for instance. If you think that a particular company has a hit on their hands then you’d buy that business, says Noah Solomon, president and chief investment officer at Toronto’s Outcome Wealth Management.

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“If I thought that company X was developing a new drug that would pass all FDA approvals and that wasn’t priced into that stock, then you have to buy that,” he says. “It’s very specific to the company—buying the entire sector wouldn’t help. You’d need that stock.”

However, if you believe that the entire biotech sector is transforming the pharmaceutical industry, and that you can’t guess the big winner, then a low-cost biotech ETF would be a better way to go.

Of course, you don’t want too much of your money in these kinds of speculative bets—only allocate a small percentage of your overall portfolio to play money. After all, you could lose it overnight. Still, if you have the cash to spend then it can be entertaining, and if you’re lucky, profitable.

“Amazon is the classic example,” says Small. “It’s gone up and up an up. It traded at $500 in 2015 and now it’s over $1,000. I wouldn’t recommend it because of its valuation, but those who believed the future of Amazon was bright bought in and it’s worked out well for them.”