The S&P/ASX 200 (Index:^AXJO) (ASX:XJO) has good companies that you should seek to own and many terrible companies you don't want to touch.
We focus so much of our time on what can go right for an investor, so let's take a moment to focus on what can — and will — go wrong from time to time.
Here are five ways investors can lose in the share market:
- Stocks, not businesses
The biggest mistake I see many investors make is thinking of the sharemarket as a way to invest in 'stocks', not businesses. Take Telstra Corporation Ltd (ASX: TLS) as an example. People describe it (and I'm guilty of it, too) as a 'good dividend stock'.
Just imagine they called it the 'business market' and not the 'share market'.
Think of the richest person in your workplace, are they a day-trader or the business owner? I rest my case.
- Volatility, not risk
Humans are emotional. Impulsive. Irrational. Investors act accordingly.
Every day, prices in the sharemarket are created by a fearful seller meeting with an impulsive buyer. A fear of missing out, the greater fool theory, and men with beards and monocles in front of lecterns have manifested a fear of price uncertainty. Dubbed 'volatility', the uncertainty that results from buyer and seller exchanging a piece of a business is not 'risk' — so long as you avoid the following…
- Short-term 'investing'
If you were to buy a business, imagine it's your local cafe, would you buy it then attempt to sell it at 100% profit in just six months, for 50% more in six days or 2% more in 10 seconds? If so, stop reading now. I've lost you.
The share market is not a place to 'get-rich-quick'. The 5,000 most popular 'trading' strategies do not work but don't take my word for it.
By the way, CFD stands for 'Contracted Financial Destruction'.
- Buying from knowledgeable sellers
Going back to the local cafe example, do you think the current cafe owner would sell it cheap because he's a good bloke? You're dreaming. Knowledgeable sellers know (see what I did there?) what the company is worth. Dick Smith, anyone? (Hint: you can avoid all IPOs and still make a lot of money)
Moreover, remember, they're called private EQUITY for a reason — and it's NOT to be fair and reasonable. I don't begrudge private equity, they're doing what they're mandated to do, and it helps keeps our markets efficient — I just wouldn't buy shares from a PE firm.
- International exposure
Australia's share market is tiny. Combined, Apple Inc., Microsoft and Alphabet Inc (formerly Google) are bigger than the entire Australian share market. In fact, Apple has enough cash to buy Commonwealth Bank of Australia (ASX: CBA) and Westpac Banking Corp (ASX: WBC) outright!
Yes, it's more complicated to open an international shares account, but your future self will thank you for putting in the extra 10 minutes.
Foolish takeaway
The business market is a great place to grow your wealth, provided you do it right. Don't make emotional decisions, resist the temptation to trade your way to riches and remember a share is just part ownership in a much larger business.
