If you wanted to lose money in the stock market, how would you do it?
This is a challenge, as the S&P returned 5.3% per year over the past 15 years (yes, even counting the dreaded 2008).
While it seems nearly impossible to lose money, a lot of work has been put into giving you ways to reliably lose money (although I’d plead with you not to use any of them).
- Find last year’s genius – Interestingly, actively managed funds that outperform one year tend to underperform the next year. If these managers predict so well, how come they don’t predict that they’ll lose their skill and retire instead? How about someone who beats the market, year after year? Good idea, except that no one beats the market year after year. But aren’t there exceptions? Kind of–Bernie Madoff “beat” the market every single year for decades, or at least seemed to until bumbling, blind, slow motion investigators tripped over the obvious fraud. Intentional frauds like Madoff are rare. Far more common are the self-deluded fund managers who think they can beat the market. Reality says that less than 3% beat the market and you can’t guess who will get lucky beforehand. If you’re inclined to offer Warren Buffett as an exception remember that he’s not really a stock picker but a sensible self-appointed fixer of poor management. Plus, these days, even Buffett has increasing trouble beating the market. If you’re being tempted to active management by last year’s genius, do a search on underperformance of active management before deciding that maybe pigs do know how to fly.
- Decide you’re the genius – Massive studies have identified many useful ideas about asset allocation (don’t put all your eggs in one basket), avoiding emotional trades, and more–ideas best served by low cost index funds. If you don’t have decades of experience, a bank of supercomputers, and dozens of analysts, you’re better off with index funds. If you do have those things, reread point 1.
- Pull out after a crash – This turns paper losses into real ones. When prices rebound, usually suddenly, being caught on the sidelines is very expensive. If you don’t need the awesome profits of America and putting your money under the mattress works for you, then you must have an exceptionally profitable mattress.
- Pull out before a crash – If you can predict the future, you are part of a huge crowd, but a deluded one. See point 1. Remember, as Paul Samuelson said, “the stock market has predicted nine of the last five recessions”. Nobody knows the future.
- Buy what’s hot – This is a time tested strategy, used in the South Sea Bubble, the Mississippi Scheme, the Nifty Fifty, the Dot Com Bubble, the Housing Bubbles, the Crash of 29, plus a whole lot more. Time tested, yes–it fails reliably.
- Buy when things cool off – Since the market goes up over time, how will you know if things are cool? What if you instead keep missing new highs? What if you can’t predict well? See point 1.
- Pay money for bad advice – Since experts can’t predict the market, what are you paying for? Better yet, why would you want it? A Certified Financial Advisor who helps you with asset allocation and planning retirement is an expert, he’s just not one that claims secret knowledge and magical powers.
- Try to get more than your fair share – In the end, all the real profit from the stock market comes from the profits made by the companies whose stocks we buy. That profit is very easy to get, just buy an index fund. Everything else is speculative profits and losses, which add up to zero (then subtract expenses). You would need to outsmart the collective pricing wisdom of the market. To beat other people, you have to find other people who are stupid, but that’s what other speculators are thinking about you… See point 1.
- Buy individual stocks – This is gambling, and gambling is very profitable, but for the casino, not the gamblers. If a stock is good, everyone else has the same information you do. If you think they’ve got the price wrong and you have it right, see points 8, 2, and 1. If you really do know something most people don’t, that’s called insider trading. It’s illegal and the penalties are unpleasant.
- Day Trade – There is an entire industry set up to enable you to lose money in this way, on the average halving your profit. This approach combines the features of 2, 3, 4, 5, 6, 8, and 9. The only way to make it worse is to add in ideas 1 and 7 too.
Given that, on the average, personal investors miss out on getting the falling-off-a-log-easy-to-get stock market return, it might be a good time to buy a low cost index fund and just hang onto it.
