There are thousands of stories of stockmarket
bloopers and the fools who made them. Even
the most successful investors admit to making
some howlers. But the thing that separates
successful investors from the rest is that they learn
from mistakes and profit from the experience.
Here are some of the dumbest things you can do
with shares.
The list is not exhaustive and some points may
appear contradictory. Investment is an art, not a
science, and the most successful investors not only have
a long-term strategy but they are flexible enough to
adjust it when circumstances warrant.
Act without a plan
Michael Blomfield, chief operating officer at CommSec,
Australia's biggest online broker, says the mistakes
investors most often make involve a lack of strategy.
For example, investors get attached to a stock and
hold on to it for too long, when taking a profit would
be a good idea. Conversely, they are too quick to snap
up what they see as a bargain, buying heavily while a
stock is still trending downwards, in a vain attempt to
pick the bottom of the market, otherwise known as
trying to catch a falling knife.
According to Blomfield, the time to decide when to
sell is before you buy. That is, if you buy a stock at $5
you might decide to sell and take a profit if it hits $6.50
or cut your losses if it falls to $4. "I encourage clients
to write this down in advance, like an agreement made
with themselves," he says.
On a similar note, if investors buy more of a
favourite stock when its price dips to average down
their entry price, they need to adjust their
predetermined selling levels.
Blomfield applauds the growing awareness among
retail investors that bad share days can throw up some
good buying opportunities, but warns that a share that
falls 20 per cent is not likely to recover overnight. He says
investors need a time frame – some idea how long they
are willing to give a stock to make their desired return.
Assume the most compliacted/expensive option is the best
Far too many people believe that if a "black box" sharetrading
system costs $10,000, it must be good; or the
most expensive adviser must be the best. Still others tie
themselves up in knots with complicated products and
trading systems when a simple, straightforward
approach would work as well or better.
No amount of gadgetry will compensate for a lack of
research or an understanding of how the market works.
Professional trader and author Daryl Guppy says one
of the most important rules is to trade in the direction
the share price is going.
In other words, buy in a clear up trend and sell in a
clear down trend. "Look at the [share price] chart. If it's
going down it's likely to continue to do so," he says.
This advice holds for investors as well as traders. For
example, Orica is a blue chip stock that has been in a
clear up trend for a year. By comparison, there was a
lot of loose talk about AMP as a recovery stock in mid-
October but, as Guppy puts it, "It's been doing an
elegant swan dive [since the start of the year], the
chances of it defying gravity are low."
Buy the hype
Too many investors are still falling for hot tips and
snake oil salesmen and their miracle "black box"
trading systems.
Michael Dunn, director of consumer
communications at the Australian Securities and
Investments Commission (ASIC), says people should
first decide if direct shares, rather than managed funds,
are for them. If so, they need to know how shares fit
into their financial plan.
Once you make the decision to invest, ASIC
recommends investors do their homework, buy shares
in companies they understand, know how long they
plan to hold the shares, learn the lessons of history,
have realistic expectations of share market returns,
understand the risk-return trade-off and your own
tolerance for risk.
Over the very long term, the Australian market has
delivered real returns (after inflation) of about 7 per cent
a year. "These are very good returns and mean investors
double their money every seven years," says Dunn.
Even though individual stocks may significantly
outperform the market average, he says, investors who
expect real returns of 10 to 20 per cent plus are being
unrealistic.
Blame the market
Just as lazy sleuths conclude the butler did it, bad
investors tend to blame the market, their advisers or
nameless insiders – in short, everyone but themselves
– for their losses.
Guppy says in his latest book, Snapshot Trading
(Wrightbooks, $39.95), that the single most powerful
self-defeating excuse for poor trading performance is
the idea that success depends on exclusive news.
Guppy's book is aimed at day traders but the principle
applies equally to investors. These days, by and large,
each investor is privy to the same news at the same
time as everyone else. Insider trading and market
manipulation does exist but it is not the all-pervading
problem many people fear.
Guppy gives a recent example of an opportunity
open to any astute investor. Newspapers reported on
November 21 that MIM was a takeover target, normally
a sure sign that the share price will rise rapidly on high
volume. Anyone reading the news over breakfast could
have bought MIM for $1.38 to $1.41 that morning
before the shares raced to $1.52 later in the day. As most
takeovers play out over several months, there is often
the possibility of a raised offer or a counter bid.
If snap decisions are too scary, Guppy points out that
many good opportunities are around for months at a
time, such as the Orica example earlier.
Chase yesterday's winners
Everyone loves a winner but too many investors lose
money by chasing yesterday's winners rather than
doing their homework to identify tomorrow's star
performers.
Nick Renton, actuary, founder, first president of the
Australian Shareholders' Association and author of
many investment books, argues that constantly
switching investments in pursuit of elusive big returns
not only encourages overtrading but buying and selling
at the wrong time.
"If you sell CBA to buy ANZ then sell ANZ to buy
CBA back again, have you achieved anything but
generate brokerage fees for your adviser and capital
gains tax for the government?" asks Renton.
Diversify too little or too much
Making sure you don't put all your money in one kind
of asset or in only two or three stocks is the best way
to avoid the risk of losing most of your capital when an
investment turns sour. Yet Lyn Armstrong, manager of
retail equities at the Australian Stock Exchange, says
one in three investors has only one stock. The average
of three stocks is little better.
This indicates that many shareholders are accidental
investors – thanks to big public issues such as Telstra
and IAG – who probably need to give some thought to
developing a more balanced share portfolio. However,
there are times when more is less.
Renton figures the benefits of diversification are lost
after 15 to 20 stocks, mathematically speaking. If your
money is spread evenly across 20 stocks and one goes
AWOL, you lose 5 per cent of your capital. If you spread
it across 100 stocks and one crashes, you lose 1 per cent.
According to Renton, the difference (between 1 and 5
per cent) is not enough to offset the added costs of
maintaining a portfolio of 100 stocks. If you are going
to play the entire field, you might as well buy a
managed fund that aims to match the performance of
a particular market index, and be done with it.
Fail to keep informed
Renton says investors need to continually educate
themselves and keep informed by reading the financial
press. Ignorance makes people vulnerable to being
conned into shonky investments or talked into taking
unnecessary risks with products such as margin loans.
Just as importantly, Renton says, failing to learn
about investment products and markets results in
missed opportunities. One such opportunity he
discusses in his latest commonsense book, Learn
More about Shares (Wrightbooks, $24.95), is the
anomaly in the pricing of News Corp ordinary and
preference shares.
Historically, News ordinary shares sell for a premium
of up to 16 per cent because they carry full voting
rights, whereas the "preferred limited voting ordinary
shares" have limited voting rights and sell at a discount.
However, preference shareholders are compensated
with a higher dividend (7.5c compared with 3c) and
they qualify for the dividend reinvestment plan. In
other words, the preference shares offer more bang for
your bucks. "Why buy the voting shares when you can
get 15 to 20 per cent more by buying non-voting
shares?" asks Renton.
Answering his own question, Renton says investors
lose out because they don't like fancy sounding names
and their brokers don't bother mentioning the
alternatives when clients ring and place a buy order
for News.
Follow the herd
Buy low and sell high is the holy grail of investment,
but, according to Renton, "mugs always do it back to
front and lose both times". Renton says his best
strategy over 40 years has been to sit and hold.
That doesn't mean investors should not sell a stock
that has performed badly over an extended period. It
does mean investors should avoid knee-jerk reactions
based on yesterday's news and risk selling in a panic
just as the market hits rock bottom, or buying in a
frenzy when prices are near their peak.
Live on borrowed time
Market commentators are fond of saying it is time in
the market that counts, not timing the market. While
there is truth in the adage, investors should remember
that time in the market isn't a guarantee of protection,
and that being a long-term investor is no excuse for
sitting on your hands when there is clear evidence that
you should sell.
As investors in WorldCom and HIH found out, there
are some corporate wounds that time won't heal.
Guppy points out that both companies were in a long
downtrend before they fell off a cliff.
That's where timing comes in. Even though very few
investors were privy to the problems at HIH before it
collapsed, a look at the share price chart should have
warned off new investors, and made existing
shareholders consider selling and looking for better
opportunities elsewhere.
ASIC's Dunn advises investors to know their time
line before they buy. Some shares that are good value
in the short term should be bought and sold quickly;
others will deliver solid returns over the very long term.
If you have a short- to medium-term financial goal,
such as accumulating a home deposit, don't park your
money in shares. Shares should form part of a longterm
investment strategy, even if you buy and sell some
stocks quickly.
Timing is important but so is price. Investors would
be wise to take a page out of investment guru Warren
Buffett's book and buy shares in quality companies at
a fair price and be patient. If a fundamentally sound
company is overpriced, wait for a price correction then
pounce. Conversely, if a good company has been
oversold, wait for proof that the price is on the mend
then buy and enjoy the ride.
Not invest
One of the biggest risks is quitting the sharemarket
when it crashes or not investing in shares at all. With
the benefit of hindsight, it is clear that the market was
a much riskier place two or three years ago – when
investors were throwing money at tech stocks with
nothing more substantial to offer than blue sky – than
it is today when shares are closer to fair value.
With a little foresight, investors can take advantage
of the fact that opportunities emerge when the market
undervalues certain stocks.
Each week financial advisor Noel Whittaker answers your
questions.
