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How To Navigate The Unpredictable Tech Market Without Getting Burned

|Includes: Facebook (FB), FIT, MSFT, T, TWTR, VZ

Today, young people are abandoning Facebook (NASDAQ:FB) for Snapchat in droves. But tomorrow, something else will take both of their places - it's the 21st-century version of keeping up with the Joneses.

This digital narcissism has led to a constant stream of tech companies clamoring for investors' attention. In fact, technology changes so quickly now that new tools and resources don't even have time to go stale before the next big thing comes around.

The industry moves fast out of necessity, so how can investors jump into the exciting world of tech without losing their shirts?

Disruptors in a Crowded Space

Of all the tech verticals, none are as hot or as unpredictable right now as financial tech.

In the past 24 months, we've seen more advancements in how people lend and borrow money, pay for goods and services, and invest than we have in the past 10 years. Banks, which have relied on traditional products to generate revenue rather than invested in new technologies, have consequently left themselves vulnerable to disruption - and fintech companies are happy to exploit that weakness by offering faster, simpler, and more cost-effective products to consumers who are disillusioned with standard banking options.

Fintech startups and crowdsourced platforms are changing the financial services industry before our eyes. The influence of crowdsourcing platforms is felt most acutely in the investment space. A startup can now raise $100,000 within two weeks on Kickstarter, receive an additional $10 million in funding, and go public under Regulation A+.

Companies can also circumvent traditional investment channels by taking their products directly to consumers. Individuals can then find and invest in these crowdfunded businesses via services like Robinhood, a free stock-trading platform. In fact, we're seeing an increasing number of competitive social platforms catering to investors of all skill levels, enabling inexperienced users to learn from knowledgeable peers and the community to exchange tips and information about different stocks.

Social media and crowdfunding are democratizing the investment industry, but the sheer volume of tech companies can make it difficult to know which ones are worthwhile investments and which are liabilities. Investors who are concerned about making smart choices during a volatile time should follow these guidelines:

1. Evaluate the risks and rewards. In the tech space, investors tend to view risks as secondary concerns when a business offers the potential for high returns. Investors are often willing to gamble on tech companies in ways they would avoid in other industries.

For instance, most people wouldn't have invested heavily in oil and gas exploration companies in 2015. However, while it's well-known that more than 75 percent of tech companies fail, investors continue to bet on them.

2. Research the market opportunity. The tech industry has a lot of momentum behind it, but investors must conduct deep due diligence before committing their money to a company. Research the market to determine whether there's a need for what the business sells, as well as whether it has a proprietary process or patents and a solid revenue plan. Investigate the founders as well. If they've launched successful products in the past, there's a strong likelihood they'll do it again.

Startups that meet all of these criteria are "right place, right time" companies. Fitbit (NYSE:FIT) is a perfect example of this. When it launched as a health tech brand in 2007, the U.S. was just coming to grips with its ever-growing obesity problem, so the market opportunity for a fitness product was huge. Fitbit's founders (James Park, a Harvard graduate and "serial entrepreneur," and Yale alumnus Eric Friedman) both had extensive business experience, which made investors confident in their combined ability to succeed.

Fitbit's product - a wearable device that counts users' steps, measures their heart rates, and helps them moderate calorie intake - was a groundbreaking concept at the time. Although Fitbit hadn't generated revenue yet when it approached investors, its founders had a defined market, a growth plan, and disruptive proprietary technology. Fast-forward to the present: Fitbit is now a $4 billion company.

The Foundry Group and True Ventures were among Fitbit's first investors, investing $2 million in its first investment round in 2008 and on other occasions leading up to its IPO. The two firms collectively earned $2 billion on an initial $2 million investment. This is a textbook case of how calculated risk, great circumstances, and patience can pay off in tech investments.

3. Invest in proven brands. There are no guarantees in investing, but market trends show that betting on big, well-established corporations pays off. For instance, Verizon (NYSE:VZ) and AT&T (NYSE:T) significantly outperformed smaller companies such as LinkedIn (LNKD) in the first quarter of 2016.

Again, it comes back to a competitive market presence and proven leadership. The big brands also tend to come back around even after they've gone through a slump. Nearly four years ago, people grumbled that Facebook was "done" because it was struggling to monetize mobile ads. But it's more than solved that problem now, and Facebook stock is worth nearly four times what it was then.

The same is happening with Twitter (NYSE:TWTR). Naysayers predict the platform is done and that users will leave in droves. Yet you see hashtags everywhere, and people rely on Twitter for real-time news during high-profile events, such as the presidential debates and the Super Bowl. The company isn't going anywhere.

Of course, not everyone follows these rules. Many investors continue to pour money into companies that aren't especially promising, despite widespread concerns that current equity valuations are unsustainable. Does this indicate the tech industry should brace for a correction in the near future?

As always, the stock market is unpredictable, and investing in tech makes it even more so. Every other day, we hear about how this gadget or that app will change people's lives. But an IPO that opened at $45 and shot up to $70 in its first four hours can take a nosedive the following week. Tech changes so rapidly that it's difficult to predict which companies are the next unicorns and which will go the way of Ask Jeeves or Myspace.

Although fintech has muddied an already complex investing landscape, clear paths do remain. Companies that have consistent leadership and strong products will prevail, no matter how volatile the market becomes.