In the stock market, numerous studies have proven that the majority of investors obtain poor results.
One of the best known was made by the company Blackrock. It presents the aggregate performance of individual investor accounts over the past 20 years.
The result of this study was that while stocks have returned 8% per year on average, the average individual investor has earned… 2% per year only :
How is it possible ? This is what we will see in this article, by exploring the 5 elements that most frequently lead investors to lose money on the stock market.
Not having an effective method
The lack of method is the first element that causes the majority of people to perform poorly in the stock market . This problem can be translated in 2 different ways:
On the one hand, there are investors who launch themselves without method and without stock market knowledge , or with a really superficial basis (they buy companies they want without precise and in-depth analysis, or they act on the recommendations of others, but without understanding the process in depth, which leads them to make mistakes).
On the other hand there are investors who have read too many stock market books and who try to mix EVERYTHING they have read into a single strategy which usually turns out to be a kind of “Frankenstein” of stock market strategies which (unlike to initial expectations) turns out to be ineffective in the long term (I was certainly guilty of this myself when I started).
As in the kitchen, where trying to randomly mix a set of quality elements rarely leads to a good dish, in the stock market, mixing a set of strategies that seem to work rarely leads to an effective method.
This phenomenon is often compounded through overconfidence bias , which often leads us to overestimate our own abilities in a specific area.
An example: few people would think they could perform open-heart surgery on someone after reading a few anatomy books, or hold an effective plea after reading a few law books, but the majority of people think they can obtain above-average results in the markets by reading a few stock market books.
Lack of method (compounded through overconfidence), is therefore one of the main reasons why most investors obtain suboptimal results.
Chasing past performances (running after winners)
It’s a phenomenon we can see happening again and again: the majority of investors tend to chase the latest “hot trend” of the moment , which often leads them to buy at the worst possible time.
We saw it just a few months ago on Bitcoin and cryptocurrencies: most retail investors felt the urge to buy it… right when prices peaked (somewhere between 15,000 and 20,000)
And if you were already there at that time, you may have seen how difficult it was to resist the pressure of the crowd. The fear of “missing the boat” in investing is often stronger than the fear of losing money, and drives even seasoned investors to make mistakes.
Since the time of “Bitcoinmania”, prices have fallen 80-90% from the highs and have (yet) not recovered. The same thing happened with gold after the 2008 crisis (which was then the hot asset of the moment), and with the internet bubble of the 2000s. And the phenomenon will undoubtedly occur again and again.
The majority of financial assets are subject to what is called the “law of reversion to the mean” over more or less long periods, which means that as a general rule, buying what has worked best out of the 3 to the past 5 years leads to poor performance.
Yet paradoxically, buying what has worked best in previous years often gives investors an illusion of security. It is for this reason that the majority of investors are terrible “market timers” and tend to buy and sell at exactly the wrong time.
Which brings us to the third reason why investors lose money in the stock market.
Hyperactivity (excessive purchases/resales)
In most areas, working harder than average leads to more results.
We often transpose this principle more or less unconsciously on the markets, thinking that following the stock market every day, and making regular purchases/resales will necessarily lead to more results than an investor who opens his account twice a year. , and who never reads the financial press.
However, it is exactly the opposite: investors who make the most trades actually have the worst results.
This graph is taken from a research paper entitled ” Trading is hazardous to your wealth “, it shows the aggregate performance of thousands of investor and trader accounts by ranking them from lowest to highest turnover (i.e. , those who buy/sell the most in 5 VS those who buy the least in 1).
The result of this study is that underperformance is strongly correlated to the turnover rate on the account: those who trade the most are those who earn the least.
This is due to several factors (including bad decisions taken repeatedly, bad market timing as explained in point 2, a lack of method as explained in point 1, but also and above all because of point number 4… )
Fees (brokerage and management)
Brokerage fees and management fees are the stock market investor’s greatest enemy.
On a few operations they often go unnoticed and we don’t care much about them, but repeated over many purchases/resales (or spread over several years), they will come (slowly but surely) to devour your performance.
Here is an example of a graph of the growth of 10,000 euros placed at 8% per year for 30 years.
- In the first case, the fund charges an annual fee of 0.2% (this is typically the case with trackers or ETFs).
- In the second case, the fund charges 2.25% per year in management fees (this is the case with certain hedge funds and so-called “active” management funds).
After 30 years, the fund that charges 2% in fees will have brought you twice as much money as the fund that charges only 0.2%.
If you place regular trades (in the case of the hyperactive traders mentioned above for example), the phenomenon of cost compounding is magnified (you may only spend 1% or 2% in fees per order, but if you make 20 or 30 operations per month, it becomes more and more difficult to be profitable ).
This is why (whatever your strategy), it is essential to use a low-cost broker who will charge you the least possible fees (personally, for example, I opted for Degiro for my ordinary securities account. They charge only a few centimes per order if you invest small amounts, which makes the impact of fees derisory for a long-term investor).
Dubious financial intermediaries (conflicts of interest)
In the previous 4 points, I mainly dealt with the case of investors who invest their own money (and the constraints they may encounter). To avoid all this, many individuals choose to delegate the management of their money to a third party (via an investment fund for example).
The problem is that these investment funds (or banks) most often operate on a biased model that puts their own financial interests ahead of yours.
If you remember point number 4: fees are the mortal enemy of good stock market performance. However, the vast majority of financial institutions will try to sell you the fund that earns them the most commissions before the one that is really the most advantageous for you .
On top of that, most funds are not necessarily built to be the best performers or have the best strategies, but they are built to be the most easily marketable.
A few weeks ago, for example, I dealt with the subject of ” green finance ” and the problem of “eco-responsible” funds, which claim to be green and ethical while holding petrochemical and polluting stocks (the “green” label being mainly used here as a marketing tool).
The result of these 2 factors (high fees and absence of a superior strategy for the most part), is that the majority of funds underperform a simple stock market index over the long term (and therefore cost their investors money):
It is for this reason (among others) that I personally prefer to manage my finances myself.
Having a solid investment method , not running after the hot trends of the moment, placing fewer stock market orders, reducing costs , and acquiring the financial knowledge that will allow you to avoid dubious financial intermediaries are all crucial points. which will allow you to mechanically improve your investment performance.
If you apply all the advice in this article, you should quickly see your performance improve, and you will avoid 5 major pitfalls that most beginner to experienced investors fall into.
(PS: Be careful however before you start (#disclaimer), investing is an activity that involves very real risks of capital loss, so be sure to be duly trained and prepared before considering going to stock).