New stock investors face the most risk at the beginning but the reason has nothing to do with investing itself
28-Feb-2023 •Dhirendra Kumar
The most dangerous time for stock investors is right at the beginning, when they have just started. Compared to equity mutual funds, and certainly compared to all debt funds and deposit-type investments, this is most unusual. In equity mutual funds, most individuals make a beginning with ELSS (tax-saving) funds. These have a three-year lock-in - you basically never go wrong. You may earn a little less or a little more, but there is never any colossal loss. Taking tax-saving into account, investors always have a good beginning with such funds. Later in their investing careers, they might make mistakes and invest in inappropriate funds, but none will face any disaster.
Stock investing is not like this. The beginning is the most dangerous time. The reason is that most investors enter stock investing with a grossly wrong idea of what it is all about, and on top of that, brokers and advisors inflate these ideas. I received an email from an investor who wanted to invest a large amount of money lying in his bank account. However, he said apologetically that he couldn't do so because he did not have time for trading every day. He felt that trading every day was the main way of making money in the equity market, and if you did not do that, then there was no point. In this view, not being able to trade every day is a serious handicap in making money on the markets. This is not a fringe view - a lot of people believe that the way to make real money on the markets is to trade every day, all day long.
The question is, how do people who have no familiarity with the equity markets arrive at this conclusion? One possibility is the marketing machine of the investment industry. When someone who has a substantial amount of money suddenly decides to invest it, what happens next depends entirely on chance. How does our potential investor decide to start off? Does he ask a friend, neighbour, or colleague? Does he start searching on the internet? The situation is primed for disaster. Unless they already know something that makes sense or know someone who gives them good guidance, fresh customers are most likely to be snared by whichever type of product has the most aggressive sales process. Unfortunately, in personal finance, the most aggressive salespeople are found in the products where they are likely to get the biggest cut of your money.
As evidence, we have this recent study from SEBI. This study kicks off with the sentence, "89% of the individual traders (i.e. 9 out of 10 individual traders) in equity F&O segment incurred losses, with an average loss of Rs 1.1 lakh during FY22..." No one who observes the equity markets should be surprised by this. That almost all individual traders make heavy losses in F&O is a known fact, but it's important that the SEBI study has put a number to it. In fact, in my observation, if the traders had been tracked for a longer period, the number would be 95 or 99 per cent.
Note that F&O (futures & options) is by far the biggest earner for brokers and exchanges and it accounts for almost all the volumes on the exchanges. Derivatives are the bread, butter, and jam of this business for the stock exchanges as well as brokers. The entire business model of the trading industry is to increase derivatives volumes. Everyone involved is constantly trying to herd their clients away from simple stock ownership towards F&O because that's where the profit is. And, as the SEBI study now proves, for the investor, that's where the losses are.
This is the reason that starting off is the most dangerous time for investors. Voices that speak of steadily investing for the long-term, like our Value Research Stock Advisor service, are few and far between. The hype of constant trading and derivatives is all over. Some investors do learn, but it takes time and losses to learn.
Suggested read: A black hole for your money
Why businesses must adapt to technological changes
Bill Ackman's guide to investing
Wealth Insight's June issue is out!
How to identify economic moats
Why you should not invest based on hype
Are your stocks financially healthy?
Why Buffett believes volatility is not risky
