One of the most common themes that come up when we talk to members of the MyWallSt community is the mistakes that they made in the past before they came to us.
A typical email might start something like this:
“Hi guys, I first started investing a few years ago but didn’t have much luck. I ended up putting money in [insert investment vehicle here] but had no real idea what I was doing. Of course, I ended up losing it all…”
In the interest of learning from others and growing together, we recently went back through a few of these messages and pulled out some of the most common mistakes. You’ll undoubtedly find people who will refute what we’re about to say, claiming that they have made plenty of money through these methods. And maybe they have.
But perhaps they have some level of expertise that the average user doesn’t. Or perhaps they just got lucky.
If you’re new to the world of investing with no prior experience, here are some quick and easy ways to lose money in the markets.
1. Leveraged ETFs
If you don’t know, an ETF is an exchange-traded fund — a vehicle that allows you to invest in multiple (sometimes hundreds) of companies with just one transaction. For example, you can invest in the S&P 500 through the Vanguard S&P 500 ETF (NYSEARCA: VOO), or in a range of international companies through the Vanguard International Dividend ETF(NASDAQ: VIGI). There are even industry-specific ETFs, like the ETFMG Prime Cyber Security ETF(NYSEARCA: HACK), which focuses specifically on cybersecurity firms.
But then there are tricky little things called leveraged ETFs. Basically, these funds use a complex formula of options to leverage their holdings. In a 3X leveraged ETF, for example, if the value of the underlying securities goes up 5%, the value of the ETF should go up 15% (and vice versa).
If you take the view that the market goes up 10% on average every year, you’d think that holding a 3X leveraged S&P 500 would be a no-brainer. I mean, why settle for 10% a year when you could get 30%?
Like all things in the stock market, however, if it sounds too good to be true — it probably is.
Firstly, holding these ETFs is very expensive. You’ll be looking at expense ratios around the 1% level compared to the 0.04% you pay with a Vanguard S&P ETF. So they are just not designed for long-term investing, to begin with.
Secondly, these ETFs are constantly rebalancing their holdings (usually daily) in order to meet their objectives. This means that, on a bad day, they end up locking in losses right away. Those losses then compound if the market continues on a downward trajectory and suddenly a couple of bad days where the market loses 5–10% equals a loss of 50% for those holding these risky ETFs.
Remember, the market is in a constant state of flux. The reason the S&P 500 has managed to deliver that 10% average return over its lifetime is because it has been resilient enough to handle the dips and recover. Leveraged ETFs might sound like a great way to boost your returns, but in reality, you’re just exposing yourself to a level of risk that no market has dealt with over the long run.
2. Penny Stocks
Penny stocks are securities that are traded on the smaller exchanges (or pink sheets) that are valued at less than $5 a share. To the novice investor, these appear to be a steal. Why buy one share of Amazon (NASDAQ: AMZN) for more than a thousand bucks when you can buy a share in this other company for just a couple of cents? After all, it couldn’t possibly go much lower than that?
For a number of reasons which we hope you are well familiar with, this is a completely illogical way to think. More people contact us regarding the money they have lost on penny stocks more than anything else. It’s an epidemic that we blame on ‘The Wolf of Wall Street’.
They often invest in one of these companies based on something they’ve read on a message forum — a tip they’ve got from someone they’ve never met about a company they know absolutely nothing about. That has bad news written all over it.
3. Marijuana Stocks
As a follow up to the above, marijuana stocks seem to be another tried and tested method of wiping out your hard earned savings.
It’s undeniable that there is a sea change in the public perception of old Mary Jane, but it’s still a minefield when it comes to investing. No doubt in the coming years we will see more states legalizing both medicinal and recreational marijuana use, but that doesn’t necessarily make it a good investment… yet.
For one thing, most companies involved in marijuana are not on the main exchanges. They are typically penny stocks sold over-the-counter. This means there is no regulatory oversight, making them rife for fraud. It also means there’s very little (if any) information on how the company is actually performing.
Then there’s also an incredibly murky competitive environment. There are currently thousands of companies trying to benefit off this shift in public perception. Which of them are going to succeed is anyone’s guess. You would have to have an incredibly deep knowledge of the industry to know which ones will survive and which will falter through competition, mismanagement — or both.
On top of all this, these companies still face a number of regulatory and legal hurdles. On the medicinal side, drug companies that do experiment with marijuana are under intense scrutiny from the FDA and find getting approval for human trials a serious challenge. Meanwhile, despite many recreational marijuana companies acting legally under state law, they are still committing a federal crime by selling marijuana. This means they can’t even get bank accounts because banks won’t touch money they believe has been acquired illegally.
We do believe that the marijuana industry will be massive in the future, but it’s just too early to pick a dominant player in the field. If you do want to dip your toe into pot stocks, however, an established company with investments into the industry might be your best step forward, like Constellation Brands (NYSE: STZ) and its sizable stake in Canopy Growth (TSE: WEED).
Unless you are an expert in commodity futures, stay well away from them. Pure and simple.
Far be it from us to tell someone not to buy some gold as a hedge against a market drop (we don’t recommend it, but each to their own), but trading commodities is something that professionals spend decades trying to master. It’s no place for novice investors.
As one commodity trader said on a recent message forum: “Do you know what backwardation is? Do you know what contango is? No? Then leave commodities alone.”
We couldn’t have said it better ourselves (whatever ‘it’ actually was).
Forex is short for foreign exchange and similar to commodities, it’s a very specialized field.
The amount of macro, socio-economic and geopolitical knowledge necessary to give yourself an edge in this field is mind-boggling. Yet there are now thousands of apps out there promising incredible returns to investors who managed to guess right on what is essentially a coin toss.
We actually had a brief interaction with someone involved in one of these apps. Now, this is anecdotal, so make of it what you will, but he told me that their average user drops about $12,000 before giving up and leaving the service. That’s their average user.
These are only the most common pitfalls new investors fall into, but you’re undoubtedly seeing a common theme throughout. When you invest money in things you don’t understand, you’re setting yourself up for trouble.
Remember, understanding something means more than just having a soundbite at hand to justify your investment. If you want to explore the options above, you need to be willing to dedicate some serious time and effort to learn what you’re doing beforehand.
Peter Lynch, one of the world’s best investors said, “Know what you own. Know why you own it.” Sometimes you’ll be wrong, but at least you’ll have learned something along the way that will help you grow and mature as an investor.
MyWallSt operates a full disclosure policy. MyWallSt staff currently hold long positions in Amazon, Constellation Brands, the ETFMG Prime Cyber Security ETF, the Vanguard International Dividend ETF, and the Vanguard S&P 500 ETF.