In financial markets, “dumb money” typically describes retail investors, while “smart money” is intended for sophisticated institutional ones such as asset managers.
As the proponents of the phrase later clarified, however, the distinction aims not to shed a negative light on mom-and-pop investors but to analyze performance gaps between “trend-followers” and those who invest ahead of the curve.
The market analysis firm Sentimentrader, who is widely credited with coining “dumb money”, explains:
“Where this term gets its meaning is that because trend-followers use different methodologies, some waiting until trends are well-established, by the time most trend-followers hop on a trend, and most aggressively, is about the time the trend is becoming exhausted.”
Venture Capital is also prone to the dumb money / smart money polarisation.
As we’ve explained in many live streams, a large majority of investors tend to make investment decisions based on who else is investing in a given startup. Paul Graham puts it best:
“By far the biggest influence on investors’ opinion of a startup is the opinion of other investors.”
That being established, what does AngelList co-founder and getting-rich-and-happy guru Naval Ravikant mean in this quote?
As usual with Naval, his aphorisms are intended to make people react and tend to be so concise they often border on the cryptic. They typically contain several layers of meaning.
In this case, he intends to highlight that anyone can invest during bubbles and potentially make some returns (“dumb money”). However, VCs who can weather a severe economic downturn, lose money, reflect on the reasons for failure, and adapt their investment strategy in the next cycle, are the smart ones. Twitted in June 2017, when every new deal seemed to blow the bubble a bit larger, his remark served as a warning for newcomers to the asset class.
Fred Wilson’s reaction to Naval’s initial tweet is telling. He commented that one should add “… or two, or three, or four [crashes].” One of the longest standing VCs still in activity, Wilson has been through enough crashes that he now adapts his investment and portfolio monitoring strategy.