Why people lose on the stockmarket

Why people lose money on shares

7 reasons why investors in the share market lose money

A flood of new investors are surging into share markets (also called stock markets). This isn’t just a New Zealand phenomenon, it’s happening worldwide.

Here are the top seven reasons that people lose money on shares, and for a few pointers on how amateur investors can turn many of these weaknesses into strengths.

1. Most shares underperform the market average

This may be a shock to many people. Most shares don’t perform very well.

Let’s look at two major measures to explore this:

  • S&P 500 – the major US market index which includes the 500 largest US corporations. This is widely accepted as the “go-to” benchmark for investing. Over the past 25 years, big winners within the S&P 500 have been few and far between, and the punishment for missing out on their returns has been commensurately severe. This is the nature of equity markets, and it is this very statistical challenge that makes stock picking so hard.
  • NZX – New Zealand’s stock exchange. Of the stocks that were listed on the NZX between 2003 and 2019, few returned more than the index average. That is to say, most underperformed the index average. How so? Because a small number of stellar performers dragged the average up. Research has shown that the probability that a randomly chosen stock would deliver below-average performance is not 50%, but over 75%!

This all means that a few strong performers drag the overall average up.

2. Trying to get rich quick

People lose money in the share market because they think and assume investing is their ticket to getting rich quick. People who think this are nearly right – except for the quick part. Share markets are the proven way to become wealthy, just not quickly.

If you have researched investing online, you usually come across reports of people who’ve become wealthy by trading shares all day. They might show off money, fancy cars, or lavish traveling, and you think it is easy money. They might even try and sell you their sure-fire system to obtain the same results, but 99% of the time or more, you will lose trying to get the same results.

A 20-year study showed that the average active share market investor earned 3.98% annually, while the S&P 500 index returned 10.16%. This is what happens when investors try to outsmart the market with constant buying and selling in an attempt at fast profits. Ignore the get rich quick pitches or the “must have” investments, instead focus on getting rich for sure.

Consider this wisdom from one of the world’s most famous, and wealthy, investors:

“The stock market is a device for transferring money from the impatient to the patient.” – Warren Buffett

3. Lack of research

There is no shortage of online articles, web forums, supposed “finance gurus,” investing newsletters, and even friends or family all touting the latest stock or fund you should be investing in. There are even professional services like Morningstar that rate various funds and stocks.

Too often though, people blindly follow these recommendations or advice without researching what they need for themselves.

Also:

  • Many of these “recommendations” can be paid for by the company whose stock or fund it is, or
  • The author is a conflicted party such as a fund manager who has just invested in a stock, then tells a news outlet how great that same stock is, or
  • An outright pump and dump scheme, perhaps on an informal online chat forum.

You are putting your hard-earned money to work, so you must understand the “why” and “what” before investing in something, and ensure it suits you and your unique circumstances.

4. Diversification – or lack of it

The goal with a diversified portfolio is to include various sectors of the economy, industries, and geographics that might complement each other – especially when the unexpected happens.

Lack of diversification has been the downfall of many investors, just imagine if all your wealth was held in travel, hospitality, tourism, and retail shares just before Covid-19 struck?

Why people lose money on shares

5. Fees

Many of the online investing platforms in-use by NZ investors can have significant fees, despite their slick marketing pronouncing themselves low cost. The types of fees include:

  • Either foreign exchange fees, or deposit and withdrawal fees when transferring to another currency, and
  • Brokerage higher than traditional stockbrokers for the average sum traded, and
  • Monthly subscription fees.

Sometimes the reporting of these fees isn’t as good as it could be, so investors need to proceed carefully and fully understand all the costs. It might not be immediately clear how much a 1-2% cost can eat away at your results, but over time that can compound and be a significant drag.

6. Emotions

We are all human, and a level of emotion is far from a bad thing. But with investing, emotions can create costly mistakes that drive bad decisions.

Between the media, stock market fluctuations, well-intentioned advice from others, and our natural attachment to specific assets, it’s hard not to make emotional decisions. But it’s a big reason why people lose money in the investment markets. Here are some examples of emotional investing:

  • Being too invested in a specific company because you love their product or service, you work or worked there, a family history of working there, etc.
  • You let emotions get the best of you and buy high because there are new records, and everyone is excited.
  • Conversely, when things turn to panic and the market falls, you get nervous and sell for a loss when it would have recovered had you held and kept consistently investing.
  • In our modern digital-age, too much information (being “overinformed”) can lead to issues such as paralysis by analysis, when no decision is reached due to an overwhelming amount of mostly conflicting information.

Those are just a few scenarios, but you hopefully get the picture. Remove emotions as best you can when it comes to your investing. Believe it or not, many of the examples above can be turned into advantages for amateur investors, for instance:

  • Grass-roots knowledge of how companies are performing. For example, a plumber may notice that a building supplies company is hiring plenty of people, expanding, and performing great work.
  • If an investor remains calm and collected, they can maintain their path through the inevitable ups and downs that come with investing. Not getting too emotional when things are good, and the same when short-term results turn bad.
  • The information-age has democratised investing. Nowadays even the most amateur investor with an internet connection can access nearly all the information available to trained professional investors.

7. No reason why

Before doing anything important, it’s crucial to understand why.

If you don’t know why you want to invest, you can set yourself up for failure.

How? If the purpose of an investment is unclear, then you probably don’t care too much either. Practically, this may lead to a lack of investment monitoring, or for younger readers may lead to fading commitment when it comes to investing regularly to build up a sizeable investment stash.

Try to develop some goals for your current and future finances.

  • Is your purpose to have assets for the future, accelerate towards retirement, make a major purchase, retire early? Then you should also have a plan in place.
  • What assets are going to get you to your goals, how much can you afford to risk currently, what and where are you investing in?

Your goals and your plan will surely change over time too, which is great! The whole point is to keep on track, engaged with your investments, making the best choices, and to be more prepared for when things change.

The bottom line – why people lose money on shares

Let’s recap the top seven reasons that people lose money on shares:

1. Most shares underperform the market average

2. Trying to get rich quick

3. Lack of research

4. Diversification – or lack of it

5. Fees

6. Emotions

7. No reason why

Despite this, with a little self-awareness and the right approach, amateur investors can turn many of these weaknesses into strengths. If you would like to discuss anything above with a trained professional, please leave your details below to arrange a complimentary initial consultation: