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.

However some of us love the art of investing, a challenge, suffering, or just the thrill of trading shares. So we invest actively, despite the odds.

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.

Freetrade offers ISA, too, and a SIPP is on the way. With such tax shelters you can trade however you want without worrying about capital gains taxes or submitting paperwork to HMRC.

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.)

Do your own research on things like the tax implications of foreign dividends, the domiciles of different funds you own, and any circumstances specific to you, such as investing as an expat.

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

As a long-term passive investor in a diversified basket of global shares via funds, it’s a perfectly acceptable strategy to ignore currency fluctuations. ((Any overseas fixed income investments, such as US government bonds, should usually be owned via a hedged ETF or similar. You can do the same with shares if you want to, at a potential small cost to your returns.))

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).

At this point you should turn to passive investing and get a new hobby. But despite the odds, some people will still to try to beat the market by finding winning managed funds or investment trusts.

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

Paying taxes on your gains or dividends can savage your returns. There’s no excuse nowadays for not dealing within ISAs or a SIPP ((Self-Invested Personal Pension)).

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!

Lars Kroijer is an occasional contributor to Monevator. His book, Investing Demystified, makes the case for index fund investing. Given the woeful performance of value funds over the past decade we thought we’d resurrect this classic post to give Lars a victory lap.

Most Monevator readers will know that I think passive investing in index funds is the rational choice for nearly everyone. A global tracker fund is the only fund most people need.

That’s because I believe most people have no edge when it comes to the extremely competitive investment markets.

I don’t even think many of us can judge whether one entire country’s stock market is better value than another, let alone pick individual stocks that will outperform.

For that reason, I think the most investors are best off using world equity index tracker funds to get their entire exposure to shares.

A world index tracker enables you to let the global capital markets do the hard work of figuring out where your money will earn the best return – because that is what is reflected in the various regional weightings in a world tracker fund.

International capital has spoken. You can just enjoy the ride.

Cheap and cheerful

Investing in a world tracker is the ultimate admission that you don’t know any better than the market.

By understanding your limitations as ‘dumb’ money and just ‘dumbly’ following the market, you actually make a very smart investing decision.

However many firms and pundits have tried to take passive investing in a different direction.

Whether it goes under the name of Smart Beta, fundamental indexing, alternative weighted indexing, or anything else, fans of these methods claim they can deliver superior returns to vanilla market weighted index funds.

The alternative-weighted funds aim to exploit various return premiums that have outperformed in the past.

For instance, there is much research that suggests that value (i.e. companies with low price-to-book or price-to-earnings ratios) and smaller companies both outperform the general market over the long-term.

Various indices and products to track them have been created to reflect this line of thinking.

Let’s put aside the poor performance of some of these strategies in recent years.

Is it rational to invest in them at all?

Dumber and dumberer

In short, I don’t think my definition of a Rational Investor – that is somebody who knows they have no edge – should buy alternative weighted investments as proxies for their market exposure.

By actively deselecting a portion of the market (that is to say buying alternatively weighted index funds with lower exposure to higher growth or larger companies, as in the example above), anyone who does so is implicitly claiming that the money invested in these deselected companies is somehow less informed than they are.

That is a pretty grand statement, and inconsistent with Rational Investing.

In contrast, I think it is probably fair to assume that those investors in high growth or large companies are highly experienced and informed, have read all the relevant books on investing, and are well aware of all aspects of the historical outperformance of various sub-sectors of the markets.

They are not stupid. In fact they are as much a part of the market as the value or smaller company investors are.

Do you really think that the trillions of dollars that follows companies like Google and Apple is somehow poorly informed?

Do you think that you know more about the markets than they do to the extent that you should deselect those stocks?

Expensive to implement

In my view anyone who suggests an alternative weighting to simply tracking the overall market looks a lot more like an active than a passive investor.

Likewise, the implicit cost of the part of the portfolio that diverges from the general index can easily approach the fee level of an actively managed fund.

Suppose an alternative weighted index has an overlap of two-thirds with the wider market, but it costs 0.3% more per year to implement than the market cap weighted tracker.

In this case you are effectively paying 1% per year on the one-third part of your investment that is different from the general market.

That is a fee level akin to some active managers.

An alternative universe

I think that many of these alternative weighted indices are created to match what has had the best historical performance and thus is easiest to sell.

If stocks with high P/E and growth rates had been the best performers over the past however many decades (as indeed they were over the last ten years) then I think the most popular alternative weighted indices would all consist of that market segment. We’d be marketed to with charts outlining all the reasons why the outperformance of expensive growth companies was expected to continue.

We would then be equally guilty of fitting the product to past returns and essentially saying that we had the insight that the future would be like the past.

And I don’t believe we can rationally say that.

Do you have edge or not?

As well as the active deselection of some parts of the market that it implies, my main issue with small company investing has to do with implementation.

Actively implementing a portfolio of smaller companies is very expensive. The trades required to build up the portfolio are subject to large bid/offer spreads and price movements if you trade in any size.

But even if you could pass the hurdle of costs, you are still left with the same question – do you really know enough about the markets to claim edge to the extent that you over-weight these stocks at the expense of other stocks in the market?

What is it that you know that the wider market doesn’t?

Whether you are picking a North American Biotech index, the Belgian index, or an index of commodities stocks, you are essentially claiming edge and an advantage in the market.

That’s no different from if you were tipping Microsoft shares to outperform.

Yet many passive investors who would scorn the ability of the average person to pick stocks will happily debate the pros and cons of these alternatively weighted indices.

I think that’s inconsistent.

Place your bets

Everyone wants a get rich quick scheme, so here is one for fans of alternative weightings.

Buy a fund tracking whatever alternative index you think is sure to outperform and sell short the broader index against it with as much money as you can borrow.

Now wait for the world to prove you right.

This will guarantee you riches, and a constant stream of lackeys from the financial media turning up to write articles about your investing brilliance!

Sounds unlikely?

I agree.

Instead: stick with the broadest and cheapest market.

Lars Kroijer’s book Investing Demystified is available from Amazon. He is donating all his profits from his book to medical research. He also wrote Confessions of a Hedge Fund Manager.

What caught my eye this week.

The question of ‘enough’ is a perennial one in the circles this blog moves in.

Seriously! We can barely check into a Personal Finance and Investing Blogger Cult Meeting before a heated debate breaks out over how much is enough given sustainable withdrawal rates, official inflation versus lifestyle inflation, ‘one more year’ syndrome – or even whose round it is.

(The argument that buying a round of drinks will tack three months onto a future retirement date is an entry-level Jedi mind trick for the likes of us).

Enough already

In the latest outing for one of the most popular-but-vague words in finance, Ashby Daniels at Retirement Field Guide deployed ‘enough’ towards finding wider contentment, writing:

Enough is a term that has very little quantitative definition, but much subjective definition.

Often, we can’t tie a specific number to enough, but we know when we are there. It’s subtle and yet definitive. It just hangs there waiting to be acknowledged or ignored.

But the important point is that we know it exists. It’s just a matter of whether we want to pay attention to our inner voice or ignore it completely.

Here’s a funny example that backs up Daniels’ point.

Long-time readers will know I’ve an on-off fascination and struggle with Bitcoin, and cryptocurrency more generally.

Back in December 2017 I um-ed and ah-ed about whether Bitcoin was in a bubble – and whether it was even a real financial asset.

A lot of digital data has flowed under the bridge since then, but the future of crypto is not what I’m thinking of in this post today.

Rather, it’s about what I did next.

You see I decided I wanted to own a bitcoin.

I could always see a possible future for bitcoin, especially as a store of value, and every day it survives the case is reinforced.

And I see owning Bitcoin as like making an investment into the part-ownership of a digital payment solution of the future.

But I have absolutely no idea how to value the stake accurately – and nor does anybody else as far I can tell. ((Note I’ve bolded the word ‘accurately’. I have heard all the arguments about the cost of hashing or comparisons with the total value of gold or the number of millionaires in the world, and so on. They can’t all be precisely right…))

So I decided I would own one bitcoin. There will only ever be 21 million of the made-up blighters, and 18 million of them are already out in the wild (or lost). Owning one out of 21 million seemed meaningful if the boldest predictions came true, but it wouldn’t kill me if the price crashed again.

This was a regret minimization approach to ‘enough Bitcoin’.

I’m not bitter

I built up to owning my notionally-shiny single bitcoin in fractional dribs and drabs during the second half of 2019 and early 2020, through more than half-a-dozen buys at much lower prices than today.

So of course when the Bitcoin price took off later this year, I was miffed that I hadn’t bought two, five, or even 10 or more bitcoins.

But I was more relieved that at least – at last – I owned one of them!

And when the price of the ephemeral asset fell $2,000 in 24 hours this week, I was a little surprised to lose a meaningful wodge of paper digital wealth so quickly.

However since I only owned one bitcoin, the impact of the dive was lost in the noise of my overall portfolio.

My conclusion? I have enough Bitcoin!

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