Why Do Stockholders Sometimes Lose Money

Why do stockholders sometimes lose money? Investing your money into the stock market does put you at risk of the ups and downs. Though, that shouldn’t big a big worry because stocks always go up long term. In today’s post, I am going to cover how people lose money in the stock market. If you find this blog post helpful then make sure to send it to a friend that would also benefit from the reading.

Investing Without Researching

Do you remember learning about the Dot Com Bubble? If not, then in plain term, people were investing heavily into online companies that weren’t even turning a profit. People were following the hype without fully looking into what they were buying into. According to Ideas.Ted.Com, it states,

There are various ways to measure the amount of wealth that was annihilated when the bubble burst. As early as November 2000, CNNFN.com pegged the losses at $1.7 trillion. But that would count only public companies. Beyond them, it’s estimated that 7,000 to 10,000 new online enterprises were launched in the late 1990s, and by mid-2003, around 4,800 of those had either been sold or gone under. Trillions of dollars in wealth vanished almost overnight.

https://ideas.ted.com/an-eye-opening-look-at-the-dot-com-bubble-of-2000-and-how-it-shapes-our-lives-today/#:~:text=There%20are%20various%20ways%20to,would%20count%20only%20public%20companies.

What was even more sad about the bubble burst was the insiders that cashed out while others suffered. The website further states,

Between September 1999 and July 2000, insiders at dot-com companies cashed out to the tune of $43 billion, twice the rate they’d sold at during 1997 and 1998. In the month before the Nasdaq peaked, insiders were selling 23 times as many shares as they bought.

Ideas.Ted.Com

This is why when you start investing as a beginner, I highly suggest watching videos and reading about different stocks that people are buy into. The best stocks to look into is ETFs and REITs.

Below is an explanation that someone on Reddit gave about how to go about buying ETFs and researching.

ETFs are effectively wrappers around a fund. Underneath the hood there are a lot of moving parts. You want to make sure that those moving parts are designed to move correctly and that the person or people in charge are doing their job. What that means in actual terms:

Who is the issuer or fund manager? The larger money managers have been the “go-to” guys for most ETFs (Vanguard, State Street, Blackrock). They own the lion’s share of ETF assets. They have enough scale to drive costs down. But there are many other smaller issuers who have great products (Invesco, Schwab, Fidelity, JPM, GS). An issuer you haven’t heard of is not necessarily a reason not to invest.

How long has the fund been around? The longer track record the better – but again – a short track record is not always a reason to avoid the fund.

What’s on the label? What is the fund’s stated purpose? Has it kept true to its mission statement? This is where track record in #2 helps…. There are 2 ways to measure this point. If the fund is an index tracker (S&P500, Russell 2000, etc…) you can compare tracking error: how close is the fund tracking the index? But tracking error is incomplete. A fund that outperforms might have higher tracking error – but for a good reason. There are a lot of intricate reasons why a fund may underperform or outperform – and a lot of it has to do with how its managed (Does the fund lend shares? Does the fund have any capital gains distributions?) If the fund does not track a well-known index – then tracking error becomes useless (vs the big indices). For example, for thematic names like MJ or ROBO or ARVR, there’s little value in tracking error. These names tend to have much narrower and focused indices with fewer names in the basket. As a result there is a lack of diversification and increased idiosyncratic risks. So the 2nd way to measure is to look under the hood – into the constituents of the basket. If the ETF is focused on self-driving cars – are the companies it holds related to that – and is the basket diversified. For example, I’d be worried if TSLA was 10% of a fund… or at least I would want to be aware of that.

How does the fund trade? Is there liquidity “on the screens” (secondary market liquidity). Can you check the ADV? Even if the ADV is low – maybe there is sufficient size on the bid and offer quotes. If you want to go down the rabbit hole here: check the average bid and offer spread on the stock as well as the premium/discount of how the fund trades versus its NAV. Many ETF companies publish this information on their websites. In the next year, this will be a regulatory requirement to help investors assess trading costs. How is the primary market liquidity – meaning does the fund have inflows and outflows. The presence of either in recent weeks or months tells me that the fund mechanics are partially working. However, fund flows are also a good way to understand what other people are looking at. Here’s a site that tracks fund flows in the last day, 1 month and 3 months.

How does the ETF fit into my portfolio? ETFs are funds – so if you have multiple ETFs they may overlap in exposures. For example, holding SPY and any US Sector large cap name (XLE, XLY, XLB, XLF..) would over-expose to those sectors (since the XL names hold the same stocks as SPY).

These are a few starting points I personally would look at when choosing an ETF. The items mentioned here are certainly not exhaustive. I also recognize that there are many items here that may make this process more complicated than it seems. Ultimately, invest for the long term, in broadly diversified indices and dont trade in and out too much (or never)

Again if you don’t like reading (which you shouldn’t) then consider watching videos on investing topics.

Trying To Play The Markets

What I mean by this is day trading, options trading, and shorting. Theses paths are more about trying to make passive income everyday instead of long term investing. Trying to make these plays can be very rewarding but also carry lots of risk. These are also the people that tend to lose the most money.

According to Etoro, there is an estimated 80% of day traders will lose money playing the game. Within 2 years the amount of traders that end up quitting is 76%. Below are 5 more facts about day trading from tradeciety.com

1) 80% of all day traders quit within the first two years. 1

2) Among all day traders, nearly 40% day trade for only one month. Within three years, only 13% continue to day trade. After five years, only 7% remain. 1

3) Traders sell winners at a 50% higher rate than losers. 60% of sales are winners, while 40% of sales are losers.2

4) The average individual investor underperforms a market index by 1.5% per year. Active traders underperform by 6.5% annually. 3

5) Day traders with strong past performance go on to earn strong returns in the future. Though only about 1% of all day traders are able to predictably profit net of fees. 1

tradeciety.com

The reason that I am throwing these stats in my this blog post is because I want you beginning investors to focus on the long term. A lot of you already feel that investing in the stock market alone is risky enough, so I want to shine some light on the others that try to make daily profit trading.

I myself like to do option trading (and now starting to learn credit spread) and have no problem with those that want to try it out. The main goal though is to invest your money into stocks that will grow the portfolio.

For those that want to get a taste of option trading then head over to my other post about how much I made on SLV calls

Closing

I hope you now have some type of understanding on why stockholders lose money sometimes when it comes to investing. If you basically follow the first step which is researching then problems with blindly invest won’t arise.

Thank you for all that are supporting The Finance Starter and don’t forget to send this blog post to someone else that could benefit from reading it.


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