The Greater Fool Theory: Foolproof Strategy, or Bubble Waiting To Pop?

Around the world, global markets have been awash with liquidity as central banks and governments promote quantitative easing. In some cases, central banks are directly participating in purchasing market securities. This flood of money has generally led to higher asset prices across markets, with markets appearing overpriced. Higher asset prices can also be attributable to the greater fool theory, as investors keep selling overpriced assets to other investors (the greater fools). In this article, we’ll examine the greater fool theory and evaluate whether it’s a sound investing strategy.

What Is the Greater Fool Theory?

The greater fool theory states that investors in a bullish market can earn positive returns by betting on an asset without regard to its fundamentals, because someone else (a “greater fool”) will buy it from them at a higher price. 

Investors acting in accordance with this theory ignore intrinsic valuations and fundamentals of assets — even if those assets are overpriced — because they expect to profit when another investor (the greater fool) is willing to pay even more. 

What drives a friendly fool to snap up these overpriced assets, sometimes to their disadvantage? Take meme coins, for example. A crypto wallet that bought $8,000 worth of Shiba Inu tokens last year is currently valued at $5.4 billion. The meme cryptocurrency hit a new all-time high on the 28th of October 2021 — a price appreciation of over 2,000,000% since the wallet bought the first Shiba Inu. For a token that originally started as somewhat of a joke, Shiba Inu may seem incredibly overpriced. It’s hard to argue that the pricing is in line with any intrinsic value.