4 ways to lose everything in the stock market
Survivorship bias -- the tendency to read about and celebrate the successes of a very small number of people -- ensures that the vast majority of us will find the task of naming legendary investors fairly easy. Warren Buffett will feature, of course. So might Benjamin Graham, George Soros and Peter Lynch.
What's less talked and written about are the many market participants who've lost huge amounts of money -- perhaps everything they own -- through ill-discipline, poor decision-making and bad luck. While we can't do much about the last of these, we can try to minimise the probability of joining this club by identifying examples of the first two.
Here then, are a few ways that could cause you to lose a lot, if not all of your money, over the course of your stock market journey.
1. Letting your emotions run wild
Round-the-clock news coverage arguably makes staying the course harder than it ever used to be. Brexit, Donald Trump -- there's never any shortage of stories that have the potential to lead investors to make impulsive (and usually erroneous) decisions, sending share prices down.
As I've become more experienced, it's become apparent to me that successful investing is less about trying to develop an ice-cool temperament and more about acknowledging that I'm as prone to behavioural foibles as anyone else. If you like, it's akin to recognising that a diet is more likely to be successful if you refrain from buying your favourite calorie-laden food than attempting to store it 'out of reach' in your house. If said treat is nowhere to be found, there's no need to expend a great deal of willpower resisting it.
Applying this idea to the stock market, it makes no sense to check your portfolio every day if you're likely to stay invested for years and possibly decades. Doing so merely raises the likelihood that you'll take action when none is required.
This isn't merely confined to periods of panic, of course. At this time of the year, markets can feel sluggish and the temptation to do something, anything, to relieve boredom can be strong.
In such a situation, I find it's worth recalling the famous study by financial services group Fidelity which showed that its most successful clients were either already dead or had completely forgotten they ever had accounts.
To be clear, the correlation between taking action and stock market success appears decidedly negative.
2. Failing to diversify
A quick look at the history of stock markets over the last two decades should explain why the idea of putting all your eggs in one basket (be it a company or sector) is anathema to Foolish investors.
Think back to the speculative dotcom boom at the end of the last century. Back then, a huge number of tech stocks soared on the back of hype and very little else. Many investors, swept along by excitement, began to value businesses based on anything but traditional metrics. We know how that story ended.
Had you invested purely in boring old banks back in 2007, you'd have also lost a lot of money, at least on paper. The fact that the share prices of such supposedly 'safe' stocks are still to recover to pre-crash levels tells you why it's so important not to rely on any single sector to perform.
Will adding a bank stock to your portfolio today hurt your chances of doing well? Probably not. In fact, the huge dividends currently being offered by the likes of Lloyds and HSBC suggest having at least a few shares in one could be sensible. Owning both is questionable though, especially if you are still committed to running a fairly concentrated portfolio.
An alternative strategy would be to have the core of your portfolio composed of cheap index trackers or exchange-traded funds, thus spreading your money over hundreds or even thousands of different companies. Any remaining cash can then be invested in a limited number of what you consider to be your best ideas.
3. Listening to bulletin board posters
I'm not averse to reading the odd bulletin board now and then. Considering the opinions of others, particularly those that diverge from your own, is a great way of avoiding confirmation bias -- the habit of only seeking out information that agrees with what you already think. Becoming attached to shares may sound absurd but its surprisingly easy. That's why reflecting on the reasons why a particular company may fail or underperform is just as important as thinking about why it might thrive.
Having said this, basing any investment decisions purely on the back of what someone posts is folly. For one, you have no idea who this person really is. Moreover, if he or she believed they knew exactly where markets were headed in the short term (tip: no one does), do you think they'd be so benevolent to post it on a free-for-all discussion board?
Even if you're aware of the identity of a bulletin board poster, it would be a mistake to assume that their attitude to risk, financial goals and investing time horizon are exactly the same as yours. Which brings me to my final point.
4. Skipping on research
The ease at which people can now buy and sell stock in companies belies the fact that consistently successful stock-picking can be both hard work and time-consuming. Unfortunately, a lot of people don't have the inclination to work their way through the full-year figures or latest news release from a company, preferring to buy into an exciting story than to question whether every chapter of that story is likely to be told.
Becoming a successful investor doesn't require a degree in finance. Nevertheless, profits can be determined by your own diligence and a willingness to evaluate a stock based on a clear, concise checklist (including qualitative aspects such as perceived economic moats in addition to numerical valuations). Doing so can only serve to strengthen your confidence in any purchase that is subsequently made.
It's easy to make a million by using a simple strategy such as tracking the FTSE 100 and letting your money work for you. Unfortunately, most investors 'over-trade' and, as a result, their returns suffer significantly...
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Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has recommended HSBC Holdings and Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.