Saving your money in the bank is never going to make you rich.
That’s because the purchasing power of your money is constantly being eroded by inflation. So, if you want to build your wealth, the solution is to put your money to work.
And that means investing it in something that will provide you with at least enough return to out-pace inflation.
Everyone has their own ideas about the best ways to invest their money and to build and protect their wealth. And there are countless options available.
You’ve got real estate, precious metals, stocks and bonds.
And you have mutual funds, ETFs, options, futures, and business interests.
Then you have a whole load of others that you might have never considered or even heard of, for that matter.
In addition to real estate, the most accessible means of investing for most people is still through the stock market. You can get exposure to this indirectly through your pension scheme, 401(k), etc, or directly through an investment or trading platform.
Let’s be clear though: there is no guarantee that investing in the stock market will make you rich. There is no guaranteed formula for success.
However, if you just sit on your cash, what is guaranteed, is that the value of your wealth will go backwards year-on-year.
So in that sense, the stock market provides a much better chance of a favourable outcome.
But there are still many people who fear the stock market and I can understand that because, although, historically, stock markets have gone up over the long-term, it doesn’t mean that people can’t lose money in the short-term or, indeed, over a 30-year period.
If you take a look at the 120-year history of the Dow Jones Industrial Average (DJIA), for example, you can probably pick out a few time periods that would have been unfavourable to investors over longer periods. But generally, the long-term trend has been up.
But these systemic risks aside, there are other reasons why people can and do lose money in the stock market, particularly in the short-term, and I want to highlight some of those for you, so that you can hopefully avoid the same mistakes.
For me, broadly speaking, the reason why people lose money in the stock market comes down to either a lack of knowledge or because decisions are ruled by emotions.
A good financial adviser or portfolio manager can address both of these areas, by bringing knowledge and experience to the table and the ability to help you make decisions that are not emotionally-driven.
Below are my Top Ten reasons why people can lose money when investing in the stock market. If you can avoid these errors, your chances of succeeding are going to be much higher.
#1 Having unrealistic expectations
Or, not understanding the correlation between risk and reward.
Some people have completely unrealistic expectations when it comes to returns and risk. They think they can expect a solid 10% return every year without being exposed to any risk. Invariably, they will experience a down year and sell out because their investment “is not working”.
Or they may say they want to be aggressive with their portfolio and then get upset when the value drops in the short-term and they end up selling out at a loss, vowing never to return to the stock market again.
The thing is, the nature of risk and return is about volatility.
If a fund can go up 10% in a year, it can probably go down 10% in a year too. You have to understand what you’re getting into.
The more volatile the investment, the more it is like sticking your money on red or black at the roulette table.
And if you can’t handle it when the house wins, then don’t play.
#2 Paying high fees
Expensive products, fees, brokers, advisers.
This is a particular source of irritation for me. There are so many products and funds out there that charge ridiculous fees.
Sure, everyone needs to make a living, but if the fees mean that you need to make 4 or 5% a year just to break even, then it’s like Mission: Impossible (or perhaps Mission: Improbable), even in a decent bull market.
Look for the low-cost alternatives.
When it comes to investing, there is rarely a correlation between the fees you pay for a fund or product and the performance of that fund or product, so don’t get fooled by advisers saying you get what you pay for.
Most of the time, a low-cost index tracker will do just as well, if not better, than the same type of actively-managed fund.
#3 Trying to time the markets
You cannot time the markets.
At least not with any consistency.
Any more than you can predict the next turn in the road by looking in the rear-view mirror. So don’t waste your time trying.
Common sense has to prevail here, because, if the markets could be timed, we’d all be rich, wouldn’t we?
Guessing what will go up and what will go down is not a reliably consistent strategy.
Instead, try thinking about time in the markets over timing the markets.
Every now and then you might get lucky and buy into something just as it takes off, but more often than not, people end up buying in high, just before the prices drop or selling out low. (See below.)
#4 Chasing performance
Some people are always looking at the funds that performed well last quarter or last year and jump in themselves on that basis only.
Ever heard the phrase “past performance is not a guarantee of future results”?
You’ll see that or a similarly-worded warning on most fund factsheets or anywhere that results of a fund are being reported.
Jumping around from fund to fund based on last year’s or recent returns is a recipe for disaster.
Chasing performance is like being late for a party.
In fact, think back to your partying days – if you’re lucky enough to still be in your partying days, you probably won’t need to think back that far – and what it is like when you rock up late.
Everyone is already drunk.
All the alcohol has gone, so you can’t catch up.
And the best-looking boys/girls are already paired off.
Would you bother or would you go home?
To use another analogy, it is like when in you’re in a traffic jam on the motorway.
You’re in the outside lane and the queue in the middle lane starts to move bit quicker than yours, so you edge across into that lane, only to find the outside lane is now moving quicker and the car that was behind you in that lane is now ahead of you.
On long journeys, sometimes it’s better to stick to the lane you’re in.
Another element of this problem is a bit like Shiny Object Syndrome.
(Yep, that’s a real thing, apparently.)
Always wanting the latest type of ETF, or the latest type of fund within a sector can quickly derail your long-term strategy and easily unbalance your asset allocation, if you’re not careful.
Lesson: if yours is a long-term strategy, stay disciplined about it!
And if you don’t have a strategy, that could be another reason why you are losing money . . .
(And feel free to contact me 🙂 )
#5 Not understanding cycles
Businesses and economies go through boom and bust cycles, which affect the stock market.
Just because one sector is down now, doesn’t mean that it will still be down next year or the year after.
And just because another sector is kicking ass now, does not mean it will necessarily be doing so in 5 years’ time.
Think about your investment horizon and how the funds you have fit in with this.
Stock markets can also rise and fall due to global events, but these sharp corrections are usually short-lived, so unless the events affect the long-term fundamentals of your portfolio holdings, it’s usually best to sit tight and ignore them.
#6 Thinking you can ‘get rich quick’
There may be the odd exception, but generally, investing in the stock market is a get-rich-slowly type of strategy.
If you approach it thinking it will make you rich overnight, you’re in for a very rude awakening.
Penny stocks, “fail-safe” day trading strategies, hot tips for new companies about to skyrocket, cryptocurrencies, ICOs and whatever else you think is the path to overnight riches . . .
Steer clear of these, because they tend to lure in people looking for quick wins. The reality is, they rarely deliver.
You’re better off sticking to the long-term, boring stuff.
Slow and steady she goes.
#7 Listening to the wrong advice
There’s an old investing adage that says when your taxi driver or hairdresser starts talking about an investment, it’s time to sell.
A recent example of that has been Bitcoin. Everybody’s auntie, granny and next-door neighbour were talking about it at the end of last year as the prices were skyrocketing and then . . .
Pop! (Yeah, he was talking about it too, hehe)
A lot of people put huge amounts of their savings and even borrowed money into this, thinking it would be a short-cut to retiring early and they are hurting now.
Listening to the wrong advice also applies to what you hear and read in the mainstream media.
Remember that the news business is only concerned about viewers, followers and readers.
They deliberately sensationalise everything.
They also conveniently ignore what they said last week if it contradicts what they are saying this week.
It’s all just noise.
What is happening in the world is reported from the here-and-now point of view.
If half of it is even true . . .
#8 Not sticking to the strategy
There is a difference between long-term investing and day trading. They are different strategies.
There is nothing wrong with running a combination of these strategies, but don’t try to apply a trading strategy to your long-term investments. See above re: chasing performance.
Understand and stick to your strategy. If you look at the bigger picture, you are less likely to let your emotions rule if the markets look rough in the short-term.
And that means doing something stupid, like selling out when you should be holding (or buying more).
Certainly, there may be times when you should ditch a losing fund, but the decision to do that should be made rationally and not as the result of a knee-jerk reaction to scare-mongering journalism.
(You’ve probably guessed that I am not a huge fan of the mainstream media!)
#9 Poor allocation
This can be both an inappropriate mix of holdings or a lack of diversification.
This comes down to knowledge really. Some people (and advisers, for that matter) don’t allocate their assets properly, so they end up being over-weight in sectors that are maybe more volatile than they thought or their holdings are not balanced enough to cope with downturns in the markets.
Another problem is over-diversification and duplication of holdings across funds. This will just dilute or limit returns.
#10 Following the herd
Conventional financial theory works on the basis that most investors are rational in the way they participate in the stock market.
However, emotions and psychology can often influence an investor to act in an unpredictable, irrational way.
There’s a relatively new field of study known as behavioural finance that looks at this and one of the key concepts is herd mentality.
You know, as in sheep.
Many investors are guilty of following the crowd when they instinctively know it is probably the wrong thing to do.
Fear of missing out (FOMO) can cause investors to rush into over-priced markets and bubbles or buy more of the same stock when really, the rational thing to do would be to sell out.
There’s this guy I know of, who dabbles in the stock market from time to time. Warren Somebody or Other. I forget his name, but he’ll be big some day, I’m sure. He always says that investors should:
“be fearful when others are greedy and be greedy when others are fearful.”
Sounds like solid advice to me.
You may have also heard the old adage, buy low and sell high.
The strange thing is, hardly anyone does.
When prices are high, greed gets the best of many of us and we either refuse to take any profits we have made off the table, because we think we are invincible stock-picking wizards, or we follow the herd and buy in fear of missing out.
And when prices go south, we sell out in fear that they are going to continue going down.
That’s behavioural finance, folks!!
The bottom line:
If your investment is long-term, stick to the long-term strategy and don’t get side-tracked by the media hype in the short-term.
Don’t be ruled by your emotions, either in times of fear or greed.
Get some help from a third party (e.g., a trusted financial adviser) who can help you look at your money objectively and rationally.
And don’t be a sheep.
Related content: How To Survive A Stock Market Crash