What Is Fool's Gold?

Any flashy but ultimately worthless investment may be called fool's gold in finance. The term originally referred only to iron pyrite, which is commonly mistaken for gold.

Key Takeaways

  • Any flashy but ultimately worthless investment may be called fool's gold in finance.
  • Fool's gold originally referred only to iron pyrite, which is commonly mistaken for gold.
  • Investments in hot stocks that seemed too good to be true, only to crash and burn, can be referred to as fool's gold.
  • Journalists and Wall Street analysts sometimes use the term to describe overvalued stocks or bonds.
  • The "greater fool theory" and fool's gold are two separate concepts, but they are frequently used together.

Understanding Fool's Gold

Iron pyrite is a shiny mineral composed of iron disulfide. It looks somewhat like real gold, so it came to be called fool's gold. Fool's gold was often found during the gold rush of the 1840s in the U.S. Many inexperienced miners believed that they hit the mother lode upon finding a cache of iron pyrite. Unlike the real thing, fool's gold is a relatively worthless commodity because of its natural abundance and lack of industrial utility.

Investments in hot stocks that seemed too good to be true, only to crash and burn, can be referred to as fool's gold. Journalists and Wall Street analysts sometimes use the term to describe overvalued stocks or bonds. They title their articles with headlines like, "Fool's Gold in High Tech" or "Mining Company Debt is Fool's Gold."

The term "fool's gold" was used to describe various cryptocurrencies as their values rose rapidly during 2016 and 2017. The name seemed particularly fitting to critics who saw cryptocurrencies as false currencies, just as fool's gold is false gold. Prices crashed in 2018, and many cryptocurrencies proved to be fool's gold. Some cryptocurrencies, such as bitcoin, survived, and their prices recovered considerably during the first half of 2019 and have since had a meteoric rise in value. As of May 28, 2021, the price of one bitcoin was $34,174.

In 2009, Gillian Tett, the Financial Times' capital markets editor, published a book called Fool's Gold. The book concentrated on the role of J.P. Morgan's innovative credit derivative team in the genesis of the financial crisis.

The idea of fool's gold was also applied to technology stocks during the 1990s. Many of the tech companies of that era originated near San Francisco, the site of the original gold rush. Some analysts warned that the dotcom bubble was a modern gold rush, and they derided tech stocks as fool's gold. The technology sector later crashed spectacularly between 2000 and 2002. While many of the technology stocks of the late 1990s were fool's gold, a few ultimately lived up to high expectations. Amazon (AMZN) and Apple (AAPL) were notably worth far more in 2019 than they were in 1999.

The Greater Fool Theory and Fool's Gold

The greater fool theory and fool's gold are two separate concepts, but they are frequently used together. A speculator may acknowledge that a particular investment has no inherent value, and then buy it because of anticipated price gains.

In this case, the speculator would be buying fool's gold based on the greater fool theory. The belief that a greater fool will pay a higher price provides a justification for knowingly investing in fool's gold.

How to Avoid Bad Investments

Although the dictum to avoid all bad investments may sound overwhelming, there are certain rules you can keep in mind that, in general, should help you avoid bad investments. Below are some rules of thumb.

Avoid Investments With Surrender Charges

Some investments carry surrender charges. This means that if you want to get out of them, you have to pay a fee. For example, if you get divorced, investments with surrender fees can cause problems. Or suppose, you are moving and want to free up funds for your down payment. If you want to access the money in your investment account, you will be stuck paying significant fees.

You could find yourself in a similar situation if you want to free up cash to cover health costs for yourself or your family. Some investments with surrender charges may offer access to a limited amount of money penalty-free, but in general, you'll want to avoid paying fees if you want to surrender an investment.

Avoid Investments With Limited Marketability

Investments with limited marketability may also be referred to as illiquid assets. These are investments that may have lower trading volumes and may be easier to get into than get out of.

Alternative investments such as real estate partnerships, private placements, private equity investments, and non-publicly traded REITs are generally more illiquid than other types of investment. The downside to having too much money in these types of investments is that you will not have easy access to your funds.

Avoid Investments With High Upfront Commissions

If you purchase an investment with a high upfront commission, your financial advisor has no financial incentive to provide ongoing service and education to you. Some examples of this include "A" share mutual funds, broker-sold annuities, and variable universal life (VUL) insurance sold as an investment.

At certain times, it may be in your best interest to invest in assets that require a commission or a transaction fee, but it should be minimal.

Avoid Confusing Investments

In reality, any good investment can be a bad investment if you don't understand it. However, if you don't understand an opportunity, you have a couple of different options. You can ask more questions, simply walk away, or hire a professional to evaluate the investment. If someone won't give you straightforward answers to your questions, it's in your best interest to just walk away.

Fool’s Gold, Fools Gold, or Fools’ Gold?

There is substantial inconsistency in the spelling of fool's gold over time. Because of the informal origins of fool's gold, the use of the term in popular culture seems to have a significant influence on its spelling. A headline in the Atlanta Constitution in 1888 containing the term "fools' gold" is commonly cited as one of the earliest recorded uses. In 1989, the Stone Roses released a highly successful song titled "Fools Gold," popularizing a different spelling. Finally, a movie starring Matthew McConaughey and Kate Hudson entitled "Fool's Gold" came to theaters in 2008. As of 2019, "fool's gold" appears to be the most common spelling.