While making a million in the stock market is difficult even for the most experienced of investors, losing a significant sum of money is relatively straightforward. It can happen to any investor, no matter what their strategy or level of experience.
One common way that investors lose money is through a lack of research. This can manifest itself in various different forms, and avoiding the most common ones could help to reduce your chances of losses in the long run. In doing so, it could also boost your chances of obtaining higher returns.
Balance sheet risk
At the present time, monetary policy in the UK and across the developed world is at the beginning of a transitional period. After a decade of rock-bottom interest rates and loose monetary policy, the tide is turning against a dovish stance on interest rates. In the US, there have already been several rate rises. In the UK, there are set to be multiple rises over the coming months.
The effect of this on company performance could be significant. Companies that have been able to generate high levels of profitability through maxing out their borrowing capacity could see their financial performance come under pressure. Profit that was previously used to invest for future growth or pay dividends may now be required to pay down debt, or even just service it.
Therefore, investors wishing to avoid losing money on shares may wish to focus on a company’s balance sheet. This could be an area which commands greater importance in the next decade than it has done in the last one.
While a company’s management can be a useful gauge of its future growth potential, a lot of the time management is wrong. Of course, managers have a vested interest in share price growth and at times they may seek to come across as confident and upbeat about the company’s future, when the reality is very different.
As such, investors may wish to rely to a greater degree on facts and figures, as well as industry trends, rather than the opinions of management teams. Thorough research into an industry and a specific stock could lead to reduced scope for losses versus focusing on management opinions and viewpoints.
A lack of research can also mean that investors take on too much risk. For example, they may fail to adequately compensate for a potential downturn in the retail sector due to the prospect of higher inflation and increasing interest rates. This may lead them to purchase stocks that, while cheap, could lack clear growth catalysts over the medium term. Similarly, smaller companies could prove to be risky – especially ones which operate solely in the UK ahead of Brexit.
Instead, focusing on macroeconomic trends and considering where an industry could be in three-plus years’ time could be a better move than simply looking for good value opportunities. And for investors who lack the time or resources to dedicate themselves to company analysis, focusing on a handful of shares and understanding their investment potential may be preferable to considering a wide range of companies without digging beneath headline figures.
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