If you recognise yourself in one of these profiles, stay away from the stock market!

Susan
By Susan April 26, 2014 21:53

If you recognise yourself in one of these profiles, stay away from the stock market!

 

“Should I invest in stocks?” is a very common stock

market question.

 

However, just like “What’s a good stock to buy right now?”, it is a sure sign that the person asking the question doesn’t know much about the financial markets.

A bad question to ask is “Should I invest in stocks, or bonds, or ETFs?” A much, much better question to ask is “Should I invest in stocks, considering my unique personality? Am I fit to invest in the financial markets as a retail investor?”

 

There are five profiles of people who really shouldn’t invest in the financial markets. Three of them are easy to spot right away, one will reveal themselves only after they’ve started to invest, and the last one won’t reveal themselves until much later… Who are these types?

Let’s start with the type I don’t even mention above:

 

The person who has no spare money at all

 

You know who I’m talking about – they don’t have any savings to speak of, and think they can propel their way to the top of the savings queue by making it big in the stock market. They have a theory: if they make €10,000, it will be “banked” and they won’t go near the markets again until they can actually afford to do it the next time. (I don’t believe this for a second.)

They don’t have a savings strategy in place, so they hope that, by directly investing in the markets, they can shortcut the long years of budgeting, planning and making sure extra money stays extra money.

Insidiously, sometimes you think you have spare money when in fact you don’t. After all, as long as you’re not struggling to make ends meet, you have “spare money”, right? Well, not exactly. Just because you’re left with a few hundred euros every months doesn’t mean you have the kind of money that would allow you to invest in the markets.

Should I invest in stocks?

Should I invest in stocks? It depends on who is asking…

Let’s say somebody has amassed a few thousand euros in order to put a down payment on a house. For now, they are contributing €300 to the pot every month. The pot is growing, but to them it’s much too slow. Why not invest the money in speculative stocks, grow their money in leaps and bounds, and be able to afford their dream house much sooner?

This is usually accompanied by an anecdote of somebody who bought a stock for a cent and then in three months, it was worth €100. They bought a yacht, are sailing the world and living off the credit union interest… or so the article they read said anyway.

But these savings are not extra money as they have a very clear purpose: they have been earmarked for a specific use. If this money disappeared, the person would be back to square one and couldn’t buy the house or would have to bear the brunt of a much bigger mortgage. Granted, they wouldn’t be destitute, but they would still be left with a big hole in their finances.

This kind of behaviour is called “regret aversion”: you want to act, and act fast, because you are afraid you will regret not acting. After all, you might make €2,000 by investing your €10,000 in the markets! But before you start to research investment options, you need to have a “third pot” in place.

I talk about the three building blocks of your finances in The Savvy Woman’s Guide to Financial Freedom. Your “current account” should comfortably cover all your regular expenses, month to month.

If you have some money left over on that account, you can transfer it to a savings account that will be your “emergency account”: if you had to pay a big fine, if you had to finance an urgent and expensive trip to the dentist, if the car broke down, if you lost your job, how would you pay for these unexpected emergencies? On the positive side, what if you had an opportunity to take the trip of a lifetime – right now! There are positive emergencies, too!

As long as you don’t have a well-stocked emergency account, think twice or even three times about investing: however conservative, investing in the financial markets always carries some risks. You might lose some or all of the money you invest. Investing money is the third pot, the one that catches the overflow from the emergency account.

Now if you have that kind of money, should you be investing in the markets? Let’s see…

 

1. Not if you’re ultra-conservative and risk-averse

 

This first type prefers to keep their savings in a Credit Union or at the Post Office. Inexperienced financial advisers might entice them by telling them that, in the financial markets, they might get 6% return, instead of 2% or less on cash deposits.

But therein lies the rub: when you tell them “This investment has always delivered 6% year on year”, they don’t hear an averaged return – they hear an interest rate, and that’s a serious problem. An investment that delivers 6% year on year, does not deliver 6% each and every year. It might be up 21% one year, then down 15% the next year.

If a financial adviser or stockbroker takes them on, they’ll be calling morning, noon and night with “I read this or that in the papers! What is happening? How will that affect my money?” Cue sleepless nights for all involved. So it’s better for their own peace of mind, too, if they stay away from investing in the financial markets.

 

2. Not if you’re a “ten-bagger”

 

At the total opposite of the scale are the people who want to buy a stock, any stock at all, just because it’s “cheap”. Often it’s because they would like to show off at dinner parties with talks of the shares they possess, and how they bought Google at its lowest and wasn’t that clever.

When I used to offer one-on-one financial markets mentoring, I had one mentee with whom I must have sat a total of four or five hours, over two days. I went through everything. ETFs, dollar cost averaging, market returns – you name it, I talked about it. I pointed out how you could get above inflation returns, and how you could get a relatively steady income through dividends, this, that, and the other… Everything I had to say was met with a thoughtful nod.

After those long hours spent painstakingly going over every little detail, when the time came to make his first transaction, he looked at me and said “You know what, I think I’ll buy the banks. Sure they’ll hardly go down any further.” My face must have fallen a mile. It’s not that an investment in the banks couldn’t have done well (some have and some haven’t since), but “Sure they’ll hardly go down any further” was the whole extent of his analysis!

Many people think that investing in the markets simply consists in buying when it’s low and selling when it’s high. This is absolutely correct – but it is much, much harder than it sounds! For example, in order to buy in a dip, you have to be willing to go completely against the crowd (who are selling). And then you only know it’s a dip in hindsight, when the graph curve has gone back up – when you’re in it, you don’t know what the future will hold: it might not be a dip at all, but a fall into a precipice! It’s so easy to look back, but all we have got is the present!

Similarly, I don’t know anybody with the foresight to know exactly when a share is topping out and they sell at that moment. You have to be willing to miss both the tops and the bottoms, take losses and give up gains, in exchange for getting some investments right and others really right. However, there isn’t a straight path to getting rich quick in the markets. If it was that easy…

Investing is approximately as fascinating as watching paint dry: you might buy today and then sell in five years’ time, perhaps. How exciting is that? I’m a finance professional, I’m a seasoned investor relatively to most lay people, I’m fascinated by the markets, the Financial Times is my constant companion, and yet I only touch my portfolio once a month. I’m not constantly shouting buy and sell orders into my phone.

 

3. Not if you’re an actual gambler

 

A gambler is a person who thinks they can control chance. Some people don’t think of themselves as gamblers because they don’t go to casinos that often. But they have, in fact, the psychological profile of a gambler.

It can happen that somebody buys a share and the share shoots through the roof and they make a handsome profit when selling it. If it happens even a couple of times in a row, they might start to think that luck had nothing to do with it, and the “self-attribution” and “illusion of control” biases take over: “This is easy”, “I’m good at this”.

They start to feel real pride and achievement when they have, in fact, been lucky. So they continue putting their money in stocks and shares for which they have “a good feeling”, trusting their “hunches”.

Then “confirmation bias” takes over: they will only look at those bits of information that confirm and reinforce their belief that they are good at this. Any adverse result will be explained away and will be somebody else’s or something else’s fault. Any success is theirs to take pride in.

This is often manifested in one extremely common behaviour: people don’t want to sell a share because they’re waiting for it to move back up. The only reason they don’t want to sell is because they don’t want to acknowledge that they made a mistake in buying it. But when you buy a security, it’s crucial to have specific reasons to do so.

Personally, I have one simple, overarching selling rule: “Sell when the reasons you bought are no longer there”. This has stood me in very good stead over the years. It’s prevented me from making mistakes, it’s triggered action where I might have been tempted to “just leave things be for a while” and it’s always removed heightened emotion from my decision making.

Now these three profiles you can spot easily after a bit of conversation, even before they start to invest. But the remaining two are a different story…

 

4. Not if you chase the news

 

That profile is extremely dangerous to themselves, but a stockbroker’s dream. They’re the ones who will call with “That stock is after rising 5%. Shouldn’t we be buying that? It fell! Maybe we should sell? I hear this company is cutting staff! Shouldn’t we sell? Or buy? Which is it?!”

They’re constantly chasing yesterday’s story, constantly chasing an elusive dream. Now at first a stockbroker will love them since they are on the phone every ten minutes giving orders, on which the stockbroker makes a commission every time. But you’re in trouble if you sell them the dream. You’ll be held responsible for not getting them that dream.

You might not recognise them until they’re investing. At the beginning they might be buying shares the same way as everybody else, as people who have an investing plan. But the minute they get in, you’ll hear “We should move, we should move, we should move!” And with that kind of behaviour, they’ll quickly wear themselves out, and they’ll wear their capital out.

 

5. Not if you don’t want to sell

 

This one is really a pity, because you won’t know them until the end. They’re the person who doesn’t realise that you don’t make money from buying a share, you only make money from selling a share. They’re the ones who say “That’s grand now, I’ll leave the shares alone for the next ten years.”

You should of course have a solid investment plan in place. But you should also review it every six months or every year at the very least. Time passes, the markets change, you have to keep an eye on that and deal with it. Which means you have to have a selling strategy, as well as a buying strategy.

So, should you be investing in the markets at all? Well if you are, the very best investment that you can make is in your own education. If you’d like to learn more about investing, check out the free bonuses to The Savvy Guide to Making More Money. I have included over sixty pages of in-depth information, as well as a complete video suite, as an introduction to investing in the financial markets. They are 100% free and you have immediate access to them here.

 

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Susan
By Susan April 26, 2014 21:53