Most people are best off using index funds to achieve their investment goals. They do not have the edge required to beat the market, and most fund managers they’d pay to do so can’t either, especially after costs.
If you don’t mind that you’ll probably lag the market return, there are worse hobbies. Provided you’ve made adequate financial provision overall, of course.
A very few of us might believe – or even have the stats to show, if we squint a bit – that we do have a market-beating edge. This might make stock picking for us rational as well as intellectually rewarding.
Even then, as my friend Lars Kroijer often reminds me, it’s a good idea for any budding Warren Buffetts with a smaller than seven-figure portfolio not to think about what the time and effort of picking shares is costing in terms of an hourly rate. Or indeed the better job or business you could pursue instead of doing all that share research.
But you (hopefully) knew all that already.
10 easy ways to lose money trading shares
If you have the rare ability to pick investments better than the market – on average – or you have reason to want to try, you’ll still need good workaday habits to make your skill pay.
There are lots of big, hairy ways to lose money when investing in or trading shares and funds.
Rubbish investment selection is route one to a lousy result, no doubt.
Other common mishaps include getting scared into selling when shares fall for no real reason, or becoming over-confident and losing whatever discipline had been delivering for you. (Your biggest enemy in the market is you.)
Even if you master your emotions and make winning investments, you can still erode your returns by bleeding money through a bunch of bad habits.
Here are ten active investing mistakes that will eat away at your returns, and make beating that tracker fund even harder.
1. Paying high fees
There’s no reason to pay a lot to buy and sell shares today given the existence of no-cost share dealing from the likes of Freetrade.
Even at traditional brokers, online dealing is cheap compared to the old days. Fees probably won’t be what determines your success once you have a big pot to invest.
Small active investors need to watch expenses like a hawk, however.
If your broker charges £15 to buy and sell shares, then a round trip will cost you £30 in fees. With an investment of £600, you’ve lost a whopping 5% on dealing fees, and more could be due on stamp duty, too. Even investors with edge will struggle to make up that friction.
Keep total dealing costs below 2.5% – and preferably far less. Use Freetrade or a similar low-to-no cost app to slash the price of entry.
If for some reason you do want to use a more traditional broker, then find a platform with a Sharebuilder type service that offers very low dealing fees (say £1.50) at set times, if you really must buy small quantities of shares.
2. Buying shares on wide spreads
The spread is the difference between the price you pay for a share, and the price you can sell at. Think of changing foreign currency at an airport booth as an analogy.
Even today you can find small cap shares on a five to 10% spread. You’d need the price of your investment to rise by at least that much just to break even – so you’re starting in the hole.
You must be especially confident a share is undervalued to buy on a large spread. Preferably you’d be in for the long haul to amortize away the initial cost over time.
Try using a Limit Order to buy such shares cheaper than the quoted price. Some brokers may claim higher dealing fees are justified by their ability to bag shares within the spread. Test them!
3. Fat-fingers making you buy the wrong share…
…or too many shares, or too few.
It happens! Online dealing has made trading cheap and easy, but if you’re too freewheeling you can slip up when placing your order.
Double check your trade is for the right shares after you’ve entered a ticker. It’s easy to make a mistake if you’re careless, especially when buying shares (or bonds) that have similar names, or multiple issues or classes.
With highly-priced or penny stocks, be careful to check you’re investing the correct amount. I’ve seen brokers fail to give the right price for some (admittedly typically obscure) shares until the final order screen.
4. Ignoring the tax implications of overseas holdings
I’m not going to begin to go into this vast subject here. Prior experience is that any attempt to do so will over-simplify this or overlook that. (And then someone will pop up in the comments and call me ignorant for not knowing there’s been a bilateral withholding tax refund treaty in place due to the legacy of the Statute of 1736 provided you deal in a SIPP on a Tuesday and send a copy of your birth certificate to a man in Panama.)
5. Being forced to deal due to tight stop losses
I don’t like stop losses very much unless you’re literally a day trader (and good luck with that) but I really don’t see the point in automatically selling shares if they drop by 3-5%.
Occasionally such a tight stop loss will prevent you taking a big hammering when a share plunges in price. Mostly you’ll just be selling because of market noise. You may quickly want to repurchase your shares – probably after they’ve risen again and you’re kicking yourself.
Trading fees can quickly mount like this, not to mention your blood pressure.
6. Ignoring liquidity
Shares that are thinly-traded can be a fertile hunting ground for small investors. They may be overlooked by professionals or untouchable for some reason, usually size. But they can come with a sting in the tail due to poor liquidity.
One sign of illiquidity is a wide spread. Another is that buying just a few thousand pounds worth of shares moves the price. Even little old me has moved the valuation of quoted companies by millions with small trades.
The price of illiquid shares can be as unpredictable as a former child star who has gone off the rails, so make sure you know why you’re invested to keep the faith. Don’t be overly worried by short-term movements if you’ve bought for the long-term.
Don’t even think about selling illiquid shares in a bad market. You’ll usually get a terrible price, followed by the pain of seeing the shares rebound when the market calms down.
7. Using too much leverage
This one is for the spreadbetters. Make sure you understand how the size of your bet per point equates to your total exposure to underlying share price moves.
Sensible folk who would never dare borrow £5,000 to buy shares can easily – and accidentally – rack up such exposure with their first spreadbet.
I’ve used spreadbetting in the past for specific reasons (and there can be tax advantages) but I’ve not done so for years. I believe most private investors are better off sticking to traditional investing.
8. Ignoring currency impacts
If you’re an active investor operating tactically and over the shorter-term, you should pay more attention to currency movements – especially the US dollar, which tends to drive a lot of other variables in the market, from emerging market debt to the gold price to the cost of energy.
Surprise events such as the EU Referendum notwithstanding, major currency pairs tend to move fairly slowly. Certainly compared to the volatility of individual shares, which can drop by 50% or more in a day.
Over a few years though currency movements add up. For example, if you spot a particular emerging market is pursuing a pro-growth agenda and you buy into its shares for the long-term, you could do worse than expected if its authorities decide to boost competitiveness by slowly depreciating their currency 30-50% versus the pound and other global benchmarks.
Remember, it’s always the currency of the underlying assets that matter when you invest overseas.
9. Paying hefty active fund management fees
One useful outcome of trading shares is you’ll soon discover it’s harder to beat the market than it looks, so you won’t have to take our word for it.
That is, provided you properly track your returns (as opposed to fooling yourself).
It’s a free country, and so long as you’re saving enough and not chasing quick returns, you can still achieve your goals with under-performing active funds, if you really must keep alive the small chance of doing better in the end.
Do make sure you appreciate the affect of fees on your returns, though.
- £100,000 invested for 20 years at a 10% return with annual fees of 1% compounds to £560,441.
- With a very slightly higher annual charge of 1.5%, you’ll end up with nearly £50,000 less.
It’s usually best to favour funds with lower fees – even active ones.
Fees buy active managers their sports cars. These managers are not bad people – most are fascinating company if you’ve got the sort of curious mind that’s drawn to active investing – and they work hard.
But as a group they fail to beat the market for the money we give them.
That’s inevitable, because active investing is a zero sum game.
10. Not using ISAs and pensions to shield yourself from tax
The environment for unsheltered investing has got more hostile over the past few years, such as with the escalation of taxes on dividends. A hike in capital gains taxes has been mooted, too.
By all means ignore tax shelters if you want to give the State a big chunk of the gains you make for the risk and effort of investing in shares.
Personally I prefer to (and gladly) pay my share of taxes on my income, and to leave my investments to compound unmolested.
Beating the market is very hard. Don’t make it even harder for yourself by doing it on behalf of HMRC!