Five ways young people can learn to invest (not gamble) in shares
Surging markets in the wake of COVID-19 have attracted a new generation of first-time investors. But rather than invest using time-honoured principles, many are trading risky stocks, cryptocurrencies, and highly leveraged contracts for difference (CFD).
For many, the big bets paid off (this time), and retail investor trading activity has continued to surge.
The Commonwealth Bank recently reported that more than 230,000 new trading accounts were opened in the December 2020 half. New platforms such as Superhero, as well as trading platforms such as eToro, are offering low cost or even zero-commission trades to attract new customers.
Unfortunately, many of these new investors are falling into some common mistakes that could spell disaster when market conditions inevitably change.
Considering the following five areas can help new players pave the way for a long and successful investment journey.
1. Consider who is giving you advice
A licensed financial planner has a legal duty to act in your best interest. They must put your interests above their own. This is not true of journalists, websites, trading platforms, or anyone offering advice on a forum.
The rise of 'social trading' brings together many forces, and not all align with an investor's best interests. The sudden surge in US gaming company GameStop, initially spurred by some users in the Reddit community WallStreetBets, is just one example.
Another is the popular trading platform eToro, where investors can 'copy' the portfolios of top traders or institutions.
eToro says investors working together in this way can potentially improve their performance because investing is no longer a zero-sum game.
This is classic momentum investing, where a group pushes a price above its fair value. Inevitably, some investors are left to pay the price when it comes back down to a level closer to the underlying fundamentals.
2. Understand valuations
Buying a share is buying a slice of a company's future earnings. Often popular stocks among first-time investors are highly speculative or have never posted a profit.
There are many ways to value stocks, such as price-earnings ratios. Investors need to learn the basics of how to value what they're buying and not just look at the brand name and latest media coverage.
If you can't identify an economic reason why a stock is going to generate future profits in the form of dividends or compounding share price growth, you shouldn't own it.
FOMO and momentum, rather than underlying
valuations, are driving too many investor decisions. Time will tell if things really were different this time. We suggest investors stick with the fundamentals.
3. Know what you're investing in and understand the risks
Fear of missing out is not a reason to invest. As the small print at the bottom of the site also warns: "All investment products have an element of risk. As share markets go up and down, so too can the value of your investment."
The relationship between risk and return is a fundamental tenet of investing. Higher returns attract higher risk, which comes in many forms. FOMO implies that few are considering the downside.
Some asset classes are more volatile than others, with highly speculative assets such as cryptocurrencies gaining in popularity. Widespread marketing also influences perceptions among retail investors that these types of assets are commonplace.
Even eToro warns its CFD investors that "you may lose more than your initial investment" and that "67% of retail investor accounts lose money when trading CFDs with this provider".
It is incumbent on investors to consider the downside – not just the upside – of their investments.
4. Define your individual goals
Someone once asked Warren Buffett why everyone doesn't just follow his investment strategy. His response: because nobody wants to get rich slowly.
It's not easy to consistently outperform the market, yet too many investors now want huge returns as quickly as possible. This is gambling, not investing.
Investors need to define sensible personal goals and understand the level of risk they are prepared to take on to achieve them. That includes asking whether they’re comfortable with the risk of particular investment options and how they will react to losses.
Investing is a long game. Nobody needs to be rich tomorrow, but chasing that goal heightens the risk of a misstep that results in permanent loss of capital. This means you'll never be rich.
5. Keep learning
Understanding assets and markets is complex – there are no short-cuts. Becoming a successful investor requires life-long learning.
There's plenty of information about investing, but most of it is ill-informed or self-serving. Staying informed without being swayed by daily market movements and headlines is a balancing act that involves ongoing effort.
Simple short books such as The Little Book That Beats the Market by Joel Greenblatt can help provide new investors with a solid foundation. Warren Buffet's investment strategy has stood up over decades. The CFA Institute also offers plenty of reputable, sound educational material.
Investors who keep learning and stay focused on the fundamentals and their long-term personal goals are the real people worth emulating.
Shapiro, J. (2021). CommSec a winner in retail investor boom. Australian Financial Review. Retrieved from https://www.afr.com/companies/financial-services/commsec-a-winner-in-retail-investor-boom-20210210-p571cw
Superhero website. (2021, March 10). Retrieved from https://www.superhero.com.au/pricing
CFD leverage remains significant despite ASIC placing new limits from March 29, 2021. For example, 10:1 for a CFD referencing a minor stock market index. Asic. (2020). Read this before trading CFDs. Read this before trading CFDs. Retrieved from https://newshub.asic.gov.au/read-this-before-trading-cfds
MORE ON Education
Dan is the Managing Director & Co-CIO of Innova Asset Management, a boutique asset consultant and investment manager specialising in multi-asset, diversified investing with a particular focus on managing risk to create robust portfolios for clients.