The no. 1 ‘hidden’ reason why people lose money in the stock market

When it comes to the stock market, you may know of investors who hop from one new investment idea to another, and tend to get all excited about how much money they could potentially make from their stock picks all the time. This behaviour is not uncommon and is mainly caused by one fundamental feature about stock markets everywhere.

But before I reveal that, I’d like to back up a bit and ask you a simple question:

‘How do the rich get richer?’

If you look at the data, the answer is pretty obvious:

Source: Visual Capitalist

From the chart above, it tells you that if you have a net worth of $100,000, your wealth mostly comprises your home, car, cash, and retirement account. But if you have a net worth of $10 million or more, your wealth is mostly held in stocks, real estate, mutual funds (typically invested in stock), and business interests (which is also stock).

The data is from a U.S. study, and I would suspect that Asians may skew slightly more in proportion toward real estate, but at the end of the day, the deduction is clear – if you want to grow your net worth, you must invest.

Here comes the next piece of the puzzle…

So if you want to invest, what should you invest in?

The prudent answer would be to invest across multiple asset classes. But if you were to compare the historical returns of different asset classes over the last 15 years, one winner stands out:

Source: Novel Investor

U.S. large cap stocks have performed the best, giving investors an average annual return of 8.19% compared to emerging market stocks, bonds, cash, and REITs (which can be used as a proxy for real estate).

So the question is… If the stock market has given investors the best historical return, why is it that people still lose money investing in the stock market?

The financial media

If you take a quick glance at the financial news today, you’d immediately notice something:

Source: Google

It is sensationalised with headlines that are worded in a way to excite readers and appeal to their emotions. And they do this because the media is incentivised to keep readers clicking and landing on their websites. (Granted, the search term I used – top stocks – for the screenshot above is slightly skewed. But the point remains about financial media producing short-term, sensationalised content.)

Don’t get me wrong. I think it is fine to craft an effective headline to garner more interest from readers as long as it’s not misleading. But at the same time, it is difficult for the average retail investor to avoid all this noise and not get swept away by the amount of sensationalism in the financial media.

Because of this, it breeds a culture where people are continually seeking the next ‘stock tip’, ‘hot stock’ or ‘top stock to buy’ when it comes to investing in the stock market. They invest in a stock hoping it would jump 10% after earnings day or double in price the next year. And if it doesn’t work out, they simply hop onto the next stock and the cycle repeats itself.

Which brings us to the hidden reason why people lose money in the stock market: liquidity.

Easy come, easy go

Ironically, the major strength of stock markets – its liquidity – also turns out to be the speculative investor’s main weakness. Because stock markets are so liquid, it is easy for anyone to buy a ‘hot stock’ hoping that it rises in price, before selling it to make a quick profit. It’s this ‘easy come, easy go’ mentality that causes many speculators to focus only their upside and ignore their downside.

However, the reverse is also true. Stock prices don’t always rise just because you want them to, and speculators usually sell in a panic when a stock goes the other way and crashes. More often than not, this form of emotions-based investing will lead you to lose money in the long run.

Now on the other hand, if stock markets were illiquid and it was difficult to trade a stock away, you’d immediately become more careful about buying a stock in the first place. You’d stop chasing after every careless stock tip and focus only on buying high-quality stocks that are likely to appreciate in value over time.

The closest analogy I can make here is with real estate. Compared to the stock market, the property market is a lot more illiquid. It can take many weeks or months before you’re able to find a buyer/seller at the right price for a property.

Because it’s a lot more difficult to buy and sell a property (also due to their higher sums), many investors are a lot more careful with their property investments because they know they could be stuck with them for a long while!

Because of this, they take the time to view multiple properties and make the effort to do their market research (What’s the last transacted price? Are there good schools nearby? What’s the land use plan in the area over the next 10 years?) before finally deciding on an investment. The mindset of a typical property investor is to buy, hold, and wait for the asset to appreciate in value over time.

So the question is: If most people can instinctively do their due diligence for their property investments, why don’t they do the same for their stock investments? And the answer is that they can, and they should.

“Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.” – Warren Buffett

The fifth perspective

If you’re still relying on stock tips or chasing the next hot stock to invest in, maybe it’s time to start treating your stock investments like long-term investments. It’s entirely fine to read the financial news to stay updated, but it’s more important not to get sucked in chasing the latest flavour of the month.

Instead, take the time to discover what makes a stock a high-quality, long-term investment. Discover how to identify companies with wide economic moats, long growth runways, and a track record of financial performance. Learn how to calculate an intrinsic value of a stock so you know when to enter/exit a stock investment at the right times.

At the end of the day, the goal is to build a watchlist of high-quality stocks that will enable you to invest and grow your portfolio over time:

If you’re a beginner and don’t have an investment process like the example above, or even if you are a more seasoned investor that’s always looking to refine or improve your investment process, you can consider using our Investment Quadrant framework to help you get started.

Whatever process you use, make sure it’s a rational investment framework that’s designed to help pick the best companies in the stock market. And take any sensationalism you read in the financial media with a pinch of salt.