What the GameStop short squeeze could mean for retirement savings
While the short-term consequences to retirement savers are likely to be minimal, long-term impacts could surface.
The country witnessed an interesting standoff in the stock market last week, as a group of individual investors connected via social media banded together to take on large hedge funds by exploiting a quirk in the system. Although it appears the activity, which captured headlines and dominated discussions for several days, is unlikely to have an immediate impact on retirement investments, the long-term impacts of the situation are somewhat unclear.
So what happened?
Hedge funds short sell shares in companies that they believe will lose value in the near term, in order to make quick profits. They do this by borrowing shares at the current price, immediately selling them, then re-buying them after the stock price falls, allowing them to pocket the difference. While short selling can be profitable when it works, it is also risky because if the stock price goes up instead of down, they could incur dramatic losses. This is the dynamic that came into play last week.
GameStop is a video game retailer that has been struggling, but its share price was hovering just under $20 in early January after trading around $5 for most of last year. Believing GameStop’s share price would eventually bottom out again, hedge funds began taking a short position in the company.
But a group of individual investors associated with the Reddit sub-group WallStreetBets banded together to buy GameStop stock in what is called a short squeeze, inflating its share price to comical levels. At its peak on January 27, GameStop shares reached an all time high of $492.02 per share, a price which valued the company at more than $23 billion. Now hedge funds are forced to buy back these shares at elevated prices to close their positions in GameStop, creating billions of dollars in losses.
So what does this mean for retirement accounts? In the immediate term, probably not much.
“People most impacted by this short squeeze are the short-sellers who lost significant money,” said Ben Reynolds, CEO and founder of Sure Dividend. “It’s unlikely GameStop’s short squeeze will impact 401(k)s or other retirement accounts, especially if you’ve diversified your portfolio. It could potentially harm long-term investments like 401(k)s if more amateur investors continue to short squeeze, causing hedge fund managers to sell more high-priced stocks like Apple to make up for their losses.”
However, market volatility triggered by GameStop activity and other market irregularities could impact some investors depending on where they are in their retirement journey.
“The biggest fear as one grows older is running out of money,” said Syed Nishat, partner at wealth management services firm Wall Street Alliance Group. “Many financial plans do not take the longer lifespan of people into consideration, especially during downturns in the market and how volatilities affect the retirement savings.”
Nishat said the GameStop short squeeze triggered volatility in small cap consumer discretionary exchange-traded funds (ETFs) and funds that had underlying investments exposed to the stocks. Investors that are close to retirement should monitor the funds or ETFs they are invested in to make sure they are properly diversified, he said.
The GameStop activity also could impact how the markets operate in the future. Robert R. Johnson, Professor of Finance at the Heider College of Business at Creighton University, noted that while many cheered the narrative of individual investors beating hedge fund managers at their own game, punishing short sellers could cause the market to operate less efficiently.
“If short selling was outlawed, investors with a negative outlook on a security would be precluded from taking a position in the security or relegated to the derivatives markets,” said Johnson. “Limiting short selling has implications for everyone, including index investors (many of whom are retirement investors) who may be buying inflated stocks for a while. Anytime there are pricing distortions in the market (and GameStop may be the mother of all pricing distortions), markets are less efficient and the likelihood that index investors will be negatively impacted grows.”
The GameStop situation also could compel 401(k) fiduciaries to re-think the use of hedge funds from a liability point of view or modify future 401(k) plan design, said Nishat.
“Many 401(k)s offer self-directed brokerage accounts where the participants can open a brokerage account and can buy or sell stocks,” Nishat said. “It’s very easy to follow social media or get involved in a chat group like Reddit and become involved in activities such as buying and selling stocks like GameStop or AMC. The Securities and Exchange Commission is already investigating this recent short squeeze incident and trying to gauge if a group was formed to fluctuate this stock price. 401(k) fiduciaries may need to revisit plan design to comply with rules and regulations to avoid potential liability.”
Kristen Beckman is a freelance writer based in Colorado. She previously was a writer and editor for ALM’s Retirement Advisor magazine and LifeHealthPro online channel. She also was a reporter for Business Insurance magazine covering workers compensation topics. Kristen graduated from the University of Missouri with a degree in journalism.
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