We find numerous theories and papers around this one of the most discussed topic: Why Retail Investors always lose money. Some of the common perceptions around say they buy at high and sell at low; they enter the markets when they are peak, and they are equity averse. But if you look at it closely retail investors incur loses only because of lack of discipline and lack of knowledge when it comes to investing.
When we are talking about lack of knowledge we are not even referring some high end mathematical models or stock picking strategies. Let’s just step back and revisit our high school math. The formula for compounded interest is:
Future Value = Present Value * (1+interest rate) ^ (number of years)
So if we want to increase the future value of our money the two governing factors are interest rate and number of years. So this brings forth the next question “What is interest rate of our investments dependent on?”
Well, if we put it in the simplest form: It is dependent on the type of Investments we make. So here comes our first hindrance: Lack of Knowledge while picking the good funds. This is the most common problem for retail investors. They hear a couple of success stories around their friends and family about how they made a fortune in stock markets. After that they start making the following resolutions:
Day 1: Open a Dmat account. Subscribe to some paper which gives news about market.
Day 2: Read all the material lying around the internet about how to pick winning stocks.
Day 3: Buy stocks.
So by and large most of the mistakes by retail investors are committed because of lack of access to proper advice.
If we get back to the compound interest calculation formula stated above, the second factor that governs the future value of investment is the number of years. The longer the time horizon the future value increases exponentially. 2^2 is 4 and 2^3 is 8. We don’t need to review all the numbers and conclusions that investing for longer times is going to give higher returns and all those stuff. Time horizon is in fact the second hindrance why retail investor loses money. They are so inclined towards profit booking that if they pick good funds, they sell it off as soon as they get good profits. If they pick bad funds they hold onto them in the hope that the fund will perform better. They hold on till it loses substantial amount and sell off. The other scenario where this time horizon plays a part is during the market recovery times. As and when they see an instance of market recovery, they start selling off their holdings.
Lack of quality advice and discipline with regards to the time horizon of investments are the only reasons why retails investors tend to lose money always.
Written By Arthayantra
