Investing in shares for nearly two decades has been good to me. It was slow going at first, but eventually compound interest started working its magic. The result is financial freedom I wouldn’t have imagined possible when I stumbled upon The Motley Fool and began to learn about investing.
Financial system meltdowns, military conflicts, and latterly a global pandemic have all been obstacles. But sooner or later growth has continued. My experience has convinced me you don’t need to do anything dramatic to benefit from the wealth creation potential of the stock market – and you don’t need to wait until your 80s to see the benefits.
Rather, you have to save and invest regularly, have a sound investment process, and stick with it.
Don’t do this at home
Spend a lot of time on investing chat forums or reading the antics of day traders on Twitter, however, and you could come away with a very different idea.
Studying price charts, dumping and repurchasing the same companies on micro moves, using leverage to amplify your gains, betting on shimmies in currency pricing, arguing about the merits of this or that hot stock like two opposing football fans – none of it is necessary. Indeed it’s mostly harmful.
To get specific, here are three things you hear a lot of noise about on the internet that I wouldn’t bother with if I were you.
Stop losses
Stop losses are standing instructions you set up with your broker to tell them to automatically sell your shares if a company’s price falls to a certain level. The idea is that you’ll be protected from large losses if the price plunges, while still being able to enjoy the upside of any gains.
To newcomers, stop losses sound like a no-lose proposition – get the gains and prevent the losses! Unfortunately it often doesn’t work that way.
Share prices always bounce around, so if you set your stop loss levels too tightly you’ll be constantly selling your shares. On the other hand, set a stop loss far below the current share price and not only are you not really protecting your investment from loss – you also have a good chance of being among those who dump their shares near the bottom after a profit warning, and not benefiting from any snapback recovery when the price firms up.
Sometimes stop losses aren’t even triggered if the price drops too sharply. This can be prevented with so-called ‘guaranteed stop losses’ but these are costlier.
Finally, stop losses encourage you to focus on the wrong thing – share prices – rather than the most important thing – the business you’re buying into. Almost all shares move around a lot over the course of a year, but over several years the value of the better companies generally goes up anyway, often by a lot.
Concentrate on buying shares in those companies!
Leveraged exchange-traded funds (ETFs)
We’ve all seen graphs showing that if you put £1,000 into the FTSE 100 a few decades ago and hung on through the highs and the lows you’d now be rich. This is the thesis behind investing in tracker funds, and letting the market make you money.
So, if markets eventually go up over the long-term and if you’re going to be sitting on your hands anyway, why not leverage up with an ETF that promises two- or even three-times the gain from a particular benchmark? Sure, the falls will also be larger, but the eventual gains will be monumental!
That all sounds good in theory – the snag is with how these ETFs actually work.
Leveraged ETFs do not simply double the return of, say, the FTSE 100 over a ten-year period. Rather, they are rebalanced on a daily basis. Without going into the complicated mathematics today, the end result is your investment will be whittled away by volatility when you buy-and-hold a leveraged ETF.
These are specialist products designed for day traders to make bets on where the market is going to go over a short period of time – perhaps hours, or even just a few minutes. And you know we think you shouldn’t do that!
Avoid like the plague.
Shorting shares
You don’t have to own equities and see the price go up in order to make money from shares. By shorting stocks, you can profit if a share price falls.
In theory, if you’re good at finding companies that are undervalued then you should be good at finding overvalued companies, too. Such shares may simply be overpriced, or you may identify companies where their statutory numbers don’t at all fit the narrative the company is telling. The best investors on the so-called ‘short side’ often profit from identifying outright frauds.
I believe short-sellers do a valuable service in keeping the market efficient. While cynical short-sellers spreading fear and doubt to profit from panicking investors certainly exist, I’d argue their number is dwarfed by those doing the same thing to puff up prices. Almost everything you read and hear about listed shares is promotional. Negative stories stand out because they’re rare.
However, despite shorting being potentially useful and profitable, I’d steer clear.
I believe shorting is harder – especially if you’re looking purely at valuation. Some of the most famous value investors in the world have been burned shorting technology shares over the past few years. Can you really do better than them?
More importantly, the maths is against you as a short-seller. The most you can make when you short a stock is 100% when its price goes to zero (and in practice you’re very unlikely to achieve that even if you’re successful, due to the mechanics of shorting). Whereas on the long side, your gains are uncapped – the very best companies can go up not by 100% but by 1,000% or more, and in just a few years, too.
Concentrate on finding the best prospects to buy and hold for long-term gains. Leave the headache of shorting to the professionals.
Forget about being fancy for long-term gains
Investing needn’t be complicated – but simple doesn’t mean easy. It takes real discipline to stick with the Foolish approach of investing in great companies for the long haul.
If you don’t think you can keep things simple, then I’d suggest that rather than make them complicated, your best bet is to put money into a global index fund every month and get on with the rest of your life. Leave the exotic stuff for your next trip to the zoo!
