Everybody wants to be in on the ground floor of the next big investment idea. The Gold Rush in California in the 1840s is a prime example. People dropped their lives and moved out west to be part of the next big money maker. They heard great success stories from the small percentage who actually prospered long-term from the Gold Rush; but never heard about the multitude of people who lost their life savings trying to be part of “the next big thing.”

People are always looking for the next “Gold Rush” in the stock market, such as Facebook, Apple, Amazon, Netflix, and Google. How often have you heard a friend or family member lament about not investing in these businesses at the beginning? Hindsight makes things look easy. The hard part is identifying what the “next big thing” is. Remember how we could not live without our Blackberry? Do you remember MySpace, Lycos, and Ask Jeeves? Where are these companies today?

Should I Invest in the Marijuana Industry?

That leads us to the big question people are asking this year – is the Marijuana industry “the next big thing?” Medical usage of marijuana is now legal in 47 states. Recreational marijuana is legal in 31 states, Washington D.C., and two countries (Canada and Uruguay). Well-established companies – including Coca-Cola, Altria Group and Corona – are looking to enter the industry. The public assumes that legalization will pass nationally, and they see now as the time to get in on the ground floor of something with great potential.

Keep in mind that although the ground swell for Federal legalization in the U.S. continues to grow with each election period, it is still illegal Federally.

Identifying the Risks Associated with Investing in the Marijuana Industry

As with all investments, identifying the risks specific to the industry is important. There are risks to investing in the marijuana industry at this stage of its infancy. As noted above, regulation risk (the risk that the laws change), could have a significant impact on the success of the marijuana industry. The industry itself is relatively new and immature; thus, there is no history to base investment decisions on.

Another significant risk in the industry is valuations. Consider when Amazon was growing in the late 1990s based on speculation, as opposed to actual revenue. The stock actually decreased when they first recorded revenue, as it was no longer speculative. Current valuations of marijuana investments reflect the growth prospects for the industry and not actual results. This type of speculation leads to large swings in market price or the fear of a potential bust. Plus, the limited number of entry points leads to volatility.

Dilution risk is a potential at this stage of the industry’s growth, as well. Dilution risk is the potential negative impact on the value of one’s shares as companies issue new shares of stock to fund expansion and growth. The estimation of sales for the industry is only $5 billion. Who will get the market share of these sales is unknown at this time. Are there current players that will be at the top of the market for a long time to come, or are there new players that will take over as the industry matures?

Another risk to consider is weather. Just like other agricultural industries, climate change and weather patterns can be a risk to the value of your investment (same as orange futures), having a positive (or negative) impact on supply.

Determine if Investing in the Marijuana Industry Fits into Your Financial Plan

Once you have educated yourself on the marijuana industry and the risks involved, there are several other factors to consider when deciding whether investing in the marijuana trend is the correct move for you. Most importantly, you need to remember your long-term goals and determine if this choice fits within your financial plan. Ask yourself whether investing in this type of opportunity will help you to meet these goals. Does your tolerance for risk, measured by both volatility and the potential for loss of principal, keep in line with an investment of this type? If your philosophy is buy-and-hold, are you willing to ride the ride and not make emotional decisions and overreact to periods of downward volatility? You need to determine in advance how much you are willing to invest and possibly lose.

Remember, Amazon started out as an on-line book store competing with Barnes & Noble and eBay. It did not start out to become the behemoth it is now. Facebook competed with MySpace. Google was competing with Ask Jeeves, Yahoo, Alta Vista, and Lycos. In fact, Google lost $6 million in 1999 and $14.5 million in 2000. Would you have stayed invested after years like that? Where is MySpace or Lycos today? When sitting at a dinner party or wine club, do you hear stories of people who invested in those companies – which were the hot thing back then?

Protect Your Portfolio Through Diversification

One way to protect your investment is through diversification. You can diversify among the supply chain (growers, distributors, retailers, dispensaries, and bio-tech companies). You can invest in companies in the marijuana industry that have other business arms. You can choose to invest in mutual funds or exchange traded funds that will help diversify your investment, as opposed to investing in single company stocks. This method is ultimately the better choice for protecting a complete loss of principal.

If you decide this is the opportunity for you, remember not to overinvest. It should be evaluated the same way as other opportunities. It should never be about just getting in on the ground floor of “the next big thing.” It should always be about investing in something that is right for your financial plan.

So, after considering your goals and risk tolerance, only invest an amount you are willing to lose. Set parameters of when you will sell your investment, whether protecting yourself on the downside or upside. Diversify your holdings along the supply chain. Don’t expect to get rich quick. Just go with the flow as the industry grows and do not make rash investment decisions based on emotions. Just chill!