Every investor hates losing money. You’re trying to build wealth, not destroy it.
The more wealth you build, the bigger the worry it is, and the more careful you need to be. So, spare a thought for Wall Street trader Bill Hwang, the founder of family office Archegos Capital Management, who may have just lost one of the world’s biggest personal fortunes, running to billions of dollars.
Your personal wealth is unlikely to be anywhere near that big, but it still matters to you. Here are seven ways ordinary investors can lose the lot, and how to make sure you don’t.
1. Taking on too much risk
Never invest more than you can afford to lose applies to everyone, regardless of how much or little money you have.
Mr Hwang appears to have forgotten this rule, making colossal $30 billion bets on US media titans Viacom, CBS and Discovery, and doubling down when their share prices plunged.
Mr Hwang had a history of risk taking. An earlier fund he founded, Tiger Asia, suffered steep losses in the 2008 crisis. Later, he was also embroiled in an insider trading scandal.
Private investors are also prone to take on more risk than they can afford, particularly in bull markets like the current one, Holly Mackay, chief executive of UK investment adviser Boring Money, says.
“Many end up backing a few high-risk investments, rather than spreading their money around or making more pedestrian choices.”
Mark Leale, head of the Dubai office for wealth manager Quilter Cheviot, says while building your wealth is exciting, you also need to protect it, especially when you are older.
“Someone approaching retirement will want to take fewer risks than someone just starting out in their 20s as they have more to lose and less time to recoup it.” Mr Leale says.
Tip: Know your limits as an investor and do not exceed them. Taking some risks can pay off, but only put a small part of your portfolio on the line.
2. Borrowing to invest
Former hedge fund manager Mr Hwang was investing money he didn’t actually have. Instead, Archegos borrowed it from Wall Street banks.
Leverage, as it’s known, can magnify your returns when things go well, but also magnify your losses when they don’t.
When his trading strategy backfired, the big banks got nervous and demanded more cash as security, known as a “margin call”. When he didn’t have it, they sold shares held on his behalf to mitigate their losses.
Azamat Sultanov, co-chief executive at high-net-worth FinTech platform Fortu Wealth, says this is a chilling reminder about the risks of leverage. “Margin calls are a real risk when trading leveraged instruments.”
Although most private investors do not employ leverage, others do. Trading app Robinhood offers this facility and many private traders caught up in the Reddit-fuelled frenzy over video games retailer GameStop used it to amplify their stakes.
Mr Sultanov recommends investing for the long term, rather than making short-term trades, and avoiding leverage. “Overtrading and overuse of leverage will only generate profits for brokers and banks.”
Tip: Losing money you have is painful enough. Losing money you don't have is much worse.
3. Getting greedy
Investors have been distracted by the super-sized gains made on US technology stocks such as electric car maker Tesla, whose share price rose more than 700 per cent last year. The astonishing rise of cryptocurrency Bitcoin has added to the sense that big money is there to be made, as has the mania over non-fungible tokens.
Unfortunately, you can lose big as well. “Short-term gains can turn into real losses very quickly, sometimes with tragic consequences,” Ms Mackay warns.
New investors are prone to this error, as they look to make money quickly, rather than slowly and steadily over the years.
Ms Mackay says everybody dreams of picking the next Amazon, but in practice it’s hard for private investors to make long-term returns from this approach.
The bulk of your portfolio should be held in a balanced spread of investment funds, she says. “This way, you have back-up if one or more of your individual stock picks turns sour,” she says.
Tip: The stock market can make you rich, but slowly. Invest regularly, spread your risk and reinvest your dividends for growth.
4. Chasing your losses
Nobody likes to make admit they made a mistake, especially investors. Instead, many stick to a losing strategy, hoping that one day it will come good, and prove their instincts to have been right all along.
Some, like Mr Hwang, see a share price reversal as an opportunity to buy more stock at a lower price, to amplify their ultimate return.
There are times when the strategy can work, Laith Khalaf, financial analyst at online platform AJ Bell, says. “Markets are erratic and can sometimes present buying opportunities in a crash as good companies are sold off with the bad.”
However, all too often companies fall in value for a very good reason, he says. “If something has fundamentally changed in the business itself, or the wider market, by doubling down you are exposing yourself to more losses.”
It isn’t easy, but that’s investing for you. “Sometimes you just have to admit you’ve got it wrong,” Mr Khalaf says.
Tip: Take emotion and personal pride out of investing. There is no shame in making a mistake, provided you learn from it.
5. Overrating your abilities
Many investors believe they can regularly beat the market by spotting opportunities that ordinary mortals miss. There is a good word for this. Vanity. As Mr Hwang has shown, picking consistent winners isn’t easy.
Rebecca O’Connor, head of pensions and savings at Interactive Investor, says another good way of losing money is to trust your gut feeling, rather than your research.
Your hunch may prove lucky, but you cannot rely on that to consistently make money. “The best way is to research a stock, sector, country or asset class, and spread your risk so that you are not relying on just one or two investments to strike it lucky.”
Even the best active fund managers struggle to beat the market, which is why so many private investors now favour low-cost index trackers such as exchange-traded funds. This takes vanity out of the equation because you do not look to beat the market, simply replicate it.
Tip: Admit it. You are not an investment genius and cannot see the future. Turn that knowledge to your advantage.
6. Buying last year’s winners
Another way to destroy your wealth is to “catch the wave too late”, Ms O’Connor says.
In other words, buy into a fast-growing company just as its luck runs out. “If you’ve heard a lot about a fund or company that has been performing very well for years, be aware that it could be due to a less buoyant period.”
Investment trends tend to go in cycles and last year’s winners can quickly prove to be this year’s losers, and vice versa.
Mr Khalaf says this may be happening with technology stocks today. “Tech continues to grab the headlines but miners, industrials and consumer discretionary stocks have all beaten tech over the past 12 months.”
Last year’s biggest loser, oil, has been the best performer lately, he says. “Sectors that looked reliable at the start of the pandemic, such as utilities, consumer staples and healthcare, have lagged as investors anticipate a vaccine-fuelled recovery.”
Tip: Beware chasing past performance, it's what happens next that counts. Buy high, sell low is a bad strategy.
7. Failing to diversify
If you are pinning your fortune on a handful of stocks as Mr Hwang was, you are in trouble if one or two underperform.
Never put all your eggs in one basket is possibly the oldest investment mantra of all, but every private investor should apply it.
That means spreading your money between shares, cash, bonds, property and other asset classes, such as gold, commodities and possibly cryptocurrencies.
Most of your long-term wealth should still be in shares, but again, diversify between different stocks, sectors and countries.
This way, if one investment crashes, it cannot destroy all your wealth. Mr Leale says stock markets are now trading “frothy valuations”, with technology and growth companies particularly expensive. “Should we see a market correction, these companies are likely to suffer the most, so make sure you are not over-exposed.”
Tip: Nobody can consistently predict where shares, bonds, gold or any other asset class will go next. By spreading your wealth around, you have inbuilt protection if any go south.
7 tips to protect and grow your wealth
- Don't take on too much risk
- Never borrow money to invest
- It's important not to become greedy; instead stay patient
- Don't chase your losses
- Don't overrate your investing abilities
- Stay away from last year's stock winners
- Ensure you diversify your investment portfolio