In this guide, we are going to be looking at both the risks and potential rewards of the cannabis industry. But we’ll also focus on how to invest in the cannabis industry. And just as important, we’ll present alternatives to make sure you remain fully diversified in other major asset classes.
The cannabis industry is, at this time at least, a very speculative industry.
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Why Invest in the Cannabis Industry?
Part of the attraction of the cannabis industry is its relative newness. The industry has become attractive since multiple US states have legalized use of marijuana. As more states have joined the ranks, the potential growth in the industry becomes obvious.
Prior to the legalization of marijuana, there was no legitimate way to make money in the cannabis industry. But as a totally new industry, it offers a level of promise not found in more predictable established sectors.
Though the real payoff for the cannabis industry is in recreational use, it does have an established track record for use in medical purposes. Marijuana is widely recognized as a painkiller. And not only does it work to minimize pain, but also to control the anxiety that often accompanies pain.
As many states have legalized medical marijuana use, the industry has created a firm foundation. But the biggest revenues are coming from those states that have legalized recreational use.
Thus far, 17 states and the District of Columbia have fully legalized marijuana use. That includes heavyweight states like California, New York, Illinois, Michigan, New Jersey, Massachusetts, Virginia and Washington.
Many other states have approved marijuana use for medical purposes, or the use of CBD. Still more states decriminalized marijuana without making it fully legal.
But the real prize for the cannabis industry will be federal legalization. While there have been several initiatives in that direction in recent years, not have passed.
Full legalization on a national scale – as opposed to mere decriminalization – would be a major windfall for the industry.
Decriminalization means individuals won’t be prosecuted for cannabis use. But it doesn’t enable companies to sell cannabis products freely. Full legalization would make that possible, and greatly expand growth of the industry.
How Much Should You Invest in the Cannabis Industry?
As a new and unproven industry, the investment you make in cannabis should be very small. Probably no more than 2% or 3% of your entire portfolio should be invested in the sector.
That may seem like very limited exposure, but the potential growth in this up-and-coming industry could be breathtaking. That small position that will limit your downside risk could nonetheless produce big returns. Since it’s an entirely speculative industry, a small position is always recommended.
Meanwhile, most of your portfolio should be invested in more traditional asset classes. This includes, first and foremost, stocks and bonds.
If you’re not sure how to invest, or you have no time the manage your own investments, consider using a robo-advisor.
One of the most popular choices is Betterment. Another is Ellevest, which is a robo-advisor that manages your portfolio specifically with women’s interests as the prime consideration. Either fund will provide complete investment management, including security selection. The portfolio will be constructed and regularly rebalanced. And it will all be done for a very low annual advisory fee that you’ll hardly notice.
If you’re getting close to retirement and you want your money totally safe, consider investing in annuities. These are insurance investment contracts where you commit funds that will produce a future income stream. It’s an excellent choice if you don’t have a pension, or if you want additional income to supplement a pension.
You may also consider adding other alternative investments to your portfolio.
One example is commercial real estate. You can invest in large commercial real estate projects with a relatively small investment through a real estate crowdfunding platform, known as CrowdStreet. Commercial real estate is a lucrative investment and CrowdStreet has been providing some impressive returns:
Why You May Not Want to Invest in the Cannabis Industry?
If you are considering investing in the cannabis industry, you should be aware of the following risks:
Cannabis may not be fully legalized on a national basis
Those states legalizing marijuana within their own borders do so in defiance of federal law. The prohibition of marijuana remains the law of the land on a national level. If federal legalization never occurs, the industry may never get much larger than it is now.
The potential for reversal of state-by-state legalization
It’s possible the federal government will assert its sovereignty and override state-level legalization. Still another possibility is new evidence on the health hazards of marijuana. That can cause states to rollback or even eliminate legalization.
The industry is very new
Apart from the nature of the cannabis industry, any new industry has the risk of being unproven. That’s certainly been true with cannabis. While there are dozens of small competitors, no single company is coming up as an industry leader.
Many of the current companies may go out of business
Some new companies are having difficulty achieving and maintaining profitability. Many of the new entries may not survive whatever the future holds for the industry.
It’s difficult to fully commit to an industry with an uncertain future
The lack of full nationwide legalization of marijuana will make it difficult for companies to fully expand. In addition, the prospect of a crackdown at the federal level can pull plug in the entire industry.
Full legalization may result in regulation that cuts into profits
One of the biggest arguments in favor of legalization is the ability of government to regulate and tax cannabis products. Those regulations and taxes could severely limit profitability.
In addition, you should be aware that the stock of many companies have experienced wild price swings.
How to Invest in the Cannabis Industry – Two Strategies
There are two primary ways how to invest in the cannabis industry. The first is investing in individual cannabis stocks, while the second is investing in cannabis ETFs.
If you’re going to invest in either security, you’ll need to have an investment brokerage account or investment app.
A popular choice among investment apps is Webull. It will provide you with the ability to trade cannabis stocks quickly and easily. Webull provides commission-free trades of individual stocks and ETFs. That means you’ll be able to invest in either without concern for fees. But Webull also offers trading in options and cryptocurrencies, expanding your investment choices, even more.
With that in mind, let’s take a closer look at the two primary strategies for how to invest in the cannabis industry.
1. Investing in Individual Cannabis Stocks
This is the most direct way to invest in the cannabis industry. In recent years, dozens of companies have sprung up to take advantage of growing interest in cannabis. Some are involved in growing cannabis, others processing it, and still others focus on distribution and sales.
The companies have come up as legalization of marijuana use has spread across the country. But despite the number of companies in the space, profitability and investment gains are a mixed bag. Relatively few stocks in the industry have produced impressive gains. Quite the opposite, many have been major money losers.
Since this article is meant to be a general discussion of how to invest in the cannabis industry, we’re not going to provide recommendations for specific cannabis stocks to invest in.
But according to Investopedia, the five fastest growing marijuana stocks are as follows:
Notice that four of the five companies listed in the screenshot above experienced major declines. This reality should serve as a cautionary tale. Despite the interest swirling around this industry, the promise has thus far proven to be much greater than the reality.
2. Investing in Cannabis Exchange Traded Funds (ETFs)
An exchange traded fund, or ETF, is a fund whose performance is tied to a very specific underlying index. The index itself represents a group of stocks with a specific industry. Just as there are ETFs that specialize in technology, healthcare, energy, and other industries, there are also several that are focused on the cannabis industry.
ETFs have the advantage of giving the ability to diversify across multiple stocks. This not only removes the necessity of choosing individual stocks, but also minimizes the risk of loss from any single stock. And because ETFs are tied to an underlying index, they make very few trades. That means they have very low expense ratios.
Just as is the case with stocks, we are not making a recommendation to invest in any specific cannabis related ETF. Because cannabis ETFs are composed of individual cannabis stocks, they reflect the performance of the industry overall. Since that has not been positive in the past year or so, the performance of the funds has similarly been negative.
The following is a list of the nine largest cannabis-related ETFs as recently published by The Motley Fool:
If you’re going to invest in any of these or any other cannabis related ETF, be sure to do your research. Find out exactly how many companies the fund holds, as well as the concentration of those holdings. Then naturally you’ll want to know exactly what the performance of the fund has been.
This is when it’s important to be reminded that past performance is not a guarantee of future returns. Past gains do not ensure future gains, any more than past losses indicate continued declines in the future.
Our intention in preparing this guide of how to invest in the cannabis industry is the present both sides of the equation – good and bad.
The cannabis industry has tremendous potential. The industry has come out of virtually nowhere, and now has dozens of companies operating in the space. As legalization sweeps the country – and perhaps one day the entire nation – some of these companies could become future blue chips.
But at the same time, caution is recommended. While legalization is moving forward, it’s future remains in question. There’s no guarantee that cannabis will be fully legalized at the federal level. And the potential for a backlash against cannabis can never be ruled out.
That’s why it’s important to maintain only a small percentage of your portfolio in cannabis-related investments. The majority should be held in more traditional investments, primarily stocks and bonds.
But if you’re willing to take a chance on this industry, particularly that it will achieve full legalization, carving out a small corner of your portfolio for cannabis stocks could prove to be one of the best investments you’ll ever make.