Pragmatic Guide to Investing in Cannabis

Considering an investment in the cannabis industry? Consider this a brief starting guide to making responsible choices. It may help you determine if considering an investment in the cannabis industry is right for you.

 

Ground Zero: What is Your Risk Tolerance?

This is such a broad question that a whole series or articles can (and has been) devoted to the topic, and for good reason. Risk tolerance, the amount of financial pain you can withstand, takes into account your age, employment, annual income, expenses, total net worth, asset allocation, long-term liabilities, personal life goals, investment objectives, cultural leanings, ethics and lifestyle.

It is not only difficult to take a snapshot of risk tolerance, it changes over time. A professional investment advisor will sit down with you over the course of (hopefully) months and years to consult with you on these things. If you have never considered any of the terms above, you should probably start considering them now. It does not matter how old you are; they are important questions that should shape even the first dollar you ever put into a stock in your life.

 

Question 1: What is your holding period?

Warren Buffett has always been fond of saying, “Our favorite holding period is forever.” He has made a buck or two in his time, so the advice is solid. But it is not practical for most of us in today’s economy, where our wants and needs constantly evolve and globalization becomes the norm. But still, if you are thinking of investing in a early-stage industry with massive growth potential, you should be thinking like a long-term shareholder.

Because month to month, or week to week, it is impossible to predict where cannabis stock prices will go. If you look across the space of more than 100 publicly trade stocks dealing with cannabis, it would not be surprising to see one rise 50% in the next month. Or drop 50%. So if you want to flip coins, you may as well go to your nearest casino and play blackjack; the ambiance will be better than your brokerage account, and at least it will remind you that you are gambling.

Investing in this space could be thought of like a marriage; you may decide to leave early, but plan on sticking it out. The people who make boatloads of money in cannabis will be long-term investors and not speculators.

 

Question 2: What are your liquidity needs?

Most regular stock brokerage accounts offer a level of liquidity we can wrap our heads around. If you want cash, you sell securities or funds, and within 3-7 days you can get back whatever proceeds you have generated, often much sooner than that.

Whether or not you ever intend to do that, it is important to remember that you can. But there are also investment options you may be interested in which offer a chance to participate in a company’s growth before publicly-traded shares become available. These private investments do not provide ready liquidity, and require a longer holding period and the acceptance of higher risk. These investments used to be restricted to “accredited investors,” but new regulations may greatly expand this pool later in the year.

 

Question 3: How much time can you spend keeping up?

Sometimes the best advice when it comes to stock investing is simply to “buy great companies and shut your eyes.” Not so when it comes to cannabis. It is far too nascent of an industry to know which companies are “great.” There may be entire swaths of industry space filled with nothing but companies that are bound to fail to a larger competitor once we hit full legalization.

If you are going to invest in this space, you will want to take an hour or two per week to keep tabs on things. Not only on your investment’s website, social media accounts and SEC filings, but also broad industry news. There is far more impact from legislation and legal news than there is in say, the consumer staples sector or the energy sector. Understand this, and if you do not want to spend the time, just wait a few years until there is a broad ETF for cannabis plays that you can buy into, much like the IBB (NYSE Arca: IBB) for biotech stocks.

 

Question 4: Statement 1: Remove Your Bias

There has been amazing progress made in the past 20 years into a key part of investing that used to be widely ignored and it is called behavioral psychology, or “the stuff in your head that keeps you from being a great investor.” It is not a niche or novel pseudo-science anymore; the experts have even handed out a Nobel Prize in Economics to a guy who was not even trained as an economist, but as a psychologist. The science is legit, and it touches us all; the only question is to what degree. Three key things to remember about behavioral psychology

1. It is real.
2. It impacts almost everybody, yet most people never realize it.
3. If you identify it in yourself and fix it, then identify it in others and capitalize on it, you stand the best chance of succeeding.

As all this relates to investing, maybe you consume cannabis, and maybe you don’t. Maybe you have and don’t care for it, but understand that others enjoy it and/or that there are vast medical uses. You could even hate cannabis. Regardless, all of these possibilities are irrelevant to the stance you should take if you decide to become an investor in cannabis stocks.

Do not let your bias infect your views of the sector. Read objectively (that is actually much harder than it sounds). A key stickler about biases is that they run deep and unconsciously, which makes them hard to notice, let alone approach the “fixing” part.

You simply can’t go reading every article that waxes poetic about the future of cannabis, then go buy some stocks thinking “Now’s the time.” Take a measured approach. Let time be your ally, not your enemy. When good news for cannabis in general comes across the tape, just about every stock related to cannabis will go up in concert. In the short term, it might not matter whether you are in Stock XYZ or ABC; in the long-term, it makes all the difference in the world. Understand this and you stand the best chance of succeeding.

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