The dark side of investing in newly public companies

2021 has been a record-breaking year where US initial public offerings (IPOs) have already raised $216 billion. But does that mean it’s a good time to dabble in IPOs?

According to behavioral finance expert, Vishal Khandelwal, the answer is simple. His advice: steer clear of IPOs.

Insiders club: IPOs typically benefit the pre-IPO investors and bankers helping the companies go public.

The more IPOs are hyped, the higher the investor demand — and the higher the price, the more pre-IPO investors/insiders make. But even without higher prices, these investors stand to gain — a win-win situation.

• For retail investors, it’s often better to wait before investing.
• But for how long? On average, US tech IPOs underperform for 5-6 months after going public — when insiders’ lockup expires and they can sell their shares.

Beware the hype: Two of the most hyped IPOs of 2020 were DoorDash (NYSE:DASH) and Snowflake (NYSE:SNOW). By the 6th month of being public companies, both were trading below their first-day closing prices.

• If you bought their stocks on the first day of trading, you’d be losing money right now.
• But if you invested 6 months later, you’d be up 16% on DoorDash and 12% on Snowflake today.

The alternative? One way to diversify between multiple IPOs is the Renaissance IPO ETF (NYSE:IPO), which holds a basket of the largest and most recently US-listed public companies. Or, just wait for a better price.