Trader looks at market graph 311 (R).
(photo credit: REUTERS/Tony Gentile)
With so much information available on the Internet and 24- hour-a-day business
TV, the rallying cry from these media sources has been for investors to manage
their own funds.
Investing is easy, they say. Not to mention that if you
pay very low fees, you can trade and trade and make lots of money.
if that is the case, why does study after study point to the fact that
do-it-yourself investors continue to under-perform the markets? What mistakes do
individual investors commonly make, and what can they do to prevent them? Inside
Many individual investors believe that when they read an article
about a particular company, they now possess information that is not widely
known. They forget that the only reason they read about it in an article is
because it is now public.
Princeton’s Burton Malkiel has argued that
markets are “efficient.”
That means all relevant information pertaining
to a specific company is reflected in the company’s stock price. From this
perspective, attempting to outperform the market is futile.
If that was
entirely the case, then a stock’s price should never move, unless there is new
news on the company. But in reality we see stock prices move day to day without
any news coming out. Why? Because it’s not necessarily important that all the
information is public or not. What is important is how investors continue to
reevaluate their analysis of the news.
It may be that the reason
individual investors continue to underperform is because the system favors large
institutional investors and not regular Joes. According to Terrance Odean, a
University of California Berkeley finance professor: “Even when the little guy
thinks he’s in the know, he is often clueless about what’s going on behind the
scenes. Not so the big guys... For an individual to not believe that he’s at an
informational disadvantage when he’s trading against guys from Goldman Sachs is
naive. It’s like deciding to play one-on-one with a professional basketball
player. You’re going to lose.”Herd mentality
Another mistake investors
make is that they tend to buy the same stocks everyone else is buying. This can
create a situation of buying once the stock has already moved up aggressively.
The goal for an investor is to buy low and sell high – not the other way
Forbes recently reported about a 2006 study in which Odean found
that “like children fighting over the same toy, investors are often attracted to
stocks because others want them. In fact, individuals are much more likely to
buy and sell the 10 percent of stocks mentioned in the news and ignore the other
“The problem with buying stocks when they’re popular rather than on
the basis of fundamental value is that they tend to be expensive and susceptible
to changes in investor sentiment. The day after a stock ranks among top
performers, two-thirds of all trades by individual investors are buys
(institutions, by contrast, tend to wait for dips in prices and trading volume).
Over the following month these hot issues under-perform the overall market by an
average 1.6 percentage points.”Over-trading
A third mistake investors
tend to make is that they trade way too much. It’s very difficult to always be
right when trading stocks actively. In fact, if you trade too much, instead of
investing in a company, you are basically gambling as to which direction a stock
I can’t tell you how many people have told me that they trade
“just to make a hundred dollars a day.” Inevitably, after about two weeks, they
give up on that strategy. Why? Because it’s not successful for the overwhelming
majority of individuals.
If it really was so easy to make that kind of
money every day, don’t you think everyone would do it? Investors need to
remember that there are no shortcuts when it comes to investing. There is
virtually no way to get rich quick in investing. By staying focused and
disciplined with your investment portfolio, you have the potential to build
wealth for the long firstname.lastname@example.org Aaron Katsman, a
licensed financial adviser in Israel and the United States, helps people with US