There have been a lot of headlines recently concerning a new ‘army’ of retail investors, opening millions of new trading accounts all over the world, including in the US, Europe, Australia and China. Online and mobile apps including Robinhood, Schwab and E-Trade are bringing trading to the masses, dramatically simplifying the buying and selling of stocks, options and other financial products. These apps appeal to hyper-connected millennials, allowing users to trade at the click of a button, gamifying the process and offering easy access to complex investment products. But is using them a smart way to build wealth?
A recent increase in retail investing – whether via these apps or through traditional brokerage firms – has triggered warnings from several financial institutions including the Central Bank of Ireland and the Australian Securities and Investments Commission (ASIC). The warnings, aimed at the record numbers of newcomers who have entered the market during the volatile trading period which accompanied Covid-19, highlight the risks involved.
As a professional financial planner who assists clients in putting together a well thought-out and sound strategy for building wealth, I am generally not a fan of this kind of retail investing. Sure, there are some savvy retail investors out there who manage their own portfolios successfully but the pitfalls are many and there are too few winners.
These are some of the pitfalls of retail investing:
Trying to time the markets
Making it easier to buy and sell shares clearly encourages investors to try and time the markets. This is hard to do at the best of times, let alone in highly volatile markets like the one we have experienced this year. The Australian Securities and Investments Commission notes that ‘Even market professionals find it hard to ‘time’ the market in a turbulent environment, and the risk of significant losses is a regular challenge.
For retail investors to attempt the same is particularly dangerous, and likely to lead to heavy losses – losses that could not happen at a worse time for many families.’
Failing to diversify
DIY investors often concentrate on single securities, which is a very risky strategy. A well constructed portfolio will be diversified across different assets, industries and geographical areas, a strategy which spreads risk. Diversification is a major contributing factor to attaining long term financial goals and I usually recommend ready diversified multi-asset portfolios to my clients for this very reason.
Basing investment decisions on emotions
Successful traders literally get high and that can encourage reckless behaviour. Emotional investing means that investor decisions on whether to buy and sell are motivated by greed or fear and this often leads to buying at the top of the market and selling at the bottom, both of which are terrible outcomes. Dependable investment strategies such as dollar cost averaging and diversification can’t match the excitement of the dopamine-induced high of a quick gain but will help to keep investors from making decisions which are driven by emotion.
Basing investment decisions on media hype
Fake news is everywhere so why would you base your investment decisions on media reports which will, at best, be outdated, often based on rumour or, at worst, made up? Short selling companies in the news is a very risky strategy which fails more often than it succeeds. Unless you have an inside track, by the time you read about something in the press, chances are it’s too late to benefit.
Not having a strategy
Being able to trade at the touch of a button encourages rash decision making, often without careful consideration of investment objectives, risk tolerance and the long term consequences of those decisions. Some retail investors will be working to a defined strategy and they may well succeed but the majority will be tempted into knee-jerk decisions which are not part of a holistic plan.
Investing money they can’t afford to lose
Overlooking lost opportunity cost
Rookie retail investors may be tempted to invest into battered stocks, penny stocks, bankruptcy stock, retail stocks, airline stocks, etc right now because they seem a bargain but beware of anything that seems too good to be true – it usually is. And losses aren’t just about the money invested but there is an additional opportunity cost of investing in volatile stocks which prove to be bad investments and this is often overlooked.
To give an example: If you invest $10,000 today and those shares are worth just $5,000 in five years time, it’s not just the $5,000 you lose but also the opportunity cost of investing that money in better performing investments. If you had earned, for example, 6% per annum on the $10,000 over the five year period you would now have a total pot of US$13,382. The ‘loss’ therefore includes the opportunity cost of the interest earned (US$3,382) and totals US$8,382.
Giving up on investment because of losses
This is a phenomenon that I witnessed in the wake of the Chinese stock market boom and bust of 2014 and 2015. Amateur investors who lost tens of thousands of dollars subsequently wrote off all investment based on their experience. They were unable to separate their own opinion and experience from the overall market, coming to the blanket conclusion that investors always lose and financial markets are a lottery rather than accepting that their bad experience is a result of bad decisions on their part. Now I’m having a déjà vu moment as the popularity of retail trading apps rises. It’s a great shame as, although investment does always involve risk, a comprehensive financial plan which involves investing into a diversified portfolio over the long term will achieve positive results.
There’s really no secret to investing to create wealth but neither are there easy shortcuts. Retail investors looking to yield quick profits often turn out to be the hares who end up losing versus the tortoises who concentrate on the long term investment horizon. For the vast majority of us building wealth takes time, patience, discipline and a sound financial plan implemented over the long term.
If you would like to know more about how I could help you construct an investment portfolio without taking unnecessary risks and be a tortoise, not a hare, just drop me a message. In these challenging times, trade carefully and stay well and safe.