People invest in the stock market to make money. No one intends to lose all their capital by buying stocks. Because the stock market is the single greatest way to create riches, investors willingly put their money into play.
Gold, bonds, real estate and even crypto pale in comparison to the wealth-generating capabilities of stocks. Deutsche Bank (NYSE: DB) recently published a study showing that over the past 100 years, equities beat out gold by 5.6% per year, housing prices by 6.6%, Treasuries by 6.8%, and oil by 8.4%. It’s clear that for investors wanting the best chance of having a comfortable retirement, investing in stocks and staying in the market for the long haul is the correct strategy.
Yet too often investors allow their emotions to get the better of them. Fear and greed drive most investing decisions, and following either of them can lead you to lose all of your money. What follows are three of the worst investing mistakes investors make. It’s not just newbies, either. Seasoned Wall Street veterans also fall victim to these failures that result in losing all their money.
While there’s no guarantee you won’t suffer losses on a stock, recognizing these forced emotional errors will minimize the pain your portfolio feels.
1. Buying penny stocks
I get it. The lure of penny stocks is in being able to control hundreds if not thousands of shares in a stock for very little money. All it takes is for the stock to move higher by literally pennies and you can make a killing.
Yet there is a very good reason you won’t find any investing legends buying penny stocks. They are typically lousy investments. Because they are so small, they are ripe for manipulation. Most so-called pump-and-dump schemes occur with penny stocks. The companies tend to latch onto what’s hot in the market right now and go with it. Electric vehicle battery stocks are soaring? They’ll say we’re going to upend the market and rival Panasonic (OTCMKTS:PCRFY)! Renewable energy is in? We’re going to be the next NextEra Energy (NYSE:NEE)!
Insiders tout how their company is about to become the next Walmart (NYSE:WMT) or Microsoft (NASDAQ:MSFT). They may even cite how the retailer and software giant were once penny stocks themselves. Walmart’s IPO price was literally just fractions of a penny ($0.008 per share to be exact). Microsoft went public at around $0.07 per share. Look at what they’re worth today!
Yet neither stock ever traded at those prices. Walmart went public at $16.50 per share and Microsoft at $21 per share. What you’re seeing today is their split-adjusted stock price. Because their stocks split so many times over the years and their value has grown, they only appear to have been penny stocks. They weren’t. Penny stocks are a minefield of risk that should be avoided at all costs.
2. Day trading
It all seems so easy. Buy a stock in the morning, wait for it to go up just a little and then hit the sell button. Bam! Instant profits. Then simply wash-rinse-repeat. Particularly now that Robinhood (NASDAQ:HOOD) led a revolution in eliminating commissions that almost all online brokerages followed, there’s not even a cost associated with quickly buying and selling shares.
The problem is the simplicity of day trading is illusory. You might be able to do it successfully a few times, maybe even for a day or two. But doing it over and over and over again, all day long, every day is impossible. Heck, jumping in and out of stocks over weeks or even quarters is tough. Every few minutes is not realistic. It’s a prescription for losing your money.
It’s also another good reason you don’t see any investing gurus practicing day trading. You just can’t maintain the pace. First, who wants to sit and watch their computer screen all day waiting for a stock to twitch a penny or two higher? Second, it gives the false impression you know the precise time to buy in or sell out of a stock. More likely you will almost always miss the top or bottom. Worse, you’ll pull the trigger too soon and watch the stock run away from you.
Warren Buffett, Peter Lynch, Benjamin Graham, and Seth Klarman are all long-term buy-and-hold investors. It’s not that they never sell, just that the time between purchase and sale is typically measured in years, not days — or seconds! Day trading is just another foolproof way to go broke.
3. Buying stocks on margin
Not all debt is bad. Companies use debt all the time to leverage their assets and make millions in the process. Mortgages can be a good use of debt too. You also can do that with your brokerage account. Sign up for a margin account and you can leverage an investment to amplify a stock’s return. That’s powerful. It is so powerful you can lose your shirt in the process.
It’s not that margin is some arcane, complicated scheme. It’s actually very easy. You’re taking a loan out on the value of your portfolio and using the proceeds to buy stock. Particularly in a rising market, it’s not difficult to lull yourself into believing you’re an investing genius. A rising tide lifts all boats after all. The problem occurs when the tide goes out and your stock suddenly falls. Margin is only good until the next downturn. That’s when you discover the pain margin brings.
A heavily margined stock that’s sharply falling can easily result in the dreaded margin call. That’s when your brokerage calls you to say either put more money into your account or it will indiscriminately sell your stocks to make up the losses. The SEC is even proposing new rules allowing brokerages to make intraday margin calls.
Judicious use of debt can be beneficial. Taking out a second mortgage to bet it all on black at the casino’s roulette table is not. Yet that’s how some people treat their margin accounts. You are just better off buying good companies at fair prices and holding onto them for the long haul. They will typically provide you with a superior return on your investment.
You don’t even need to take on debt to buy high-priced stocks. Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) shares might go for $533,000 a share, but with fractional shares even the loftiest-priced stocks are within reach. (And for Berkshire Hathaway specifically, there’s always BRK-B shares!) And you don’t have to fear selling all your assets just to pay back the debt collector if the stock price falls.
On the date of publication, Rich Duprey did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.