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Single Stock Investing: Market Trend Young Australian Investors Need To Be Wary Of

Siren call.

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Single Stock Investing: Market Trend Young Australian Investors Need To Be Wary Of

Image: @natalie.portnova

Stock market advice tends to either be speculative and risky (“stocks only go up!”) or oozing with platitudes (“it’s time in the market, not timing the market”). Historically this has led young Australians to spend most of their money on kale smoothies, Mazdas and gap years, only to turn 35, start investing properly, and wish they’d started earlier.

RELATED: The Best Australian Shares To Buy Right Now

Generalisation? Sure. But ASX investor studies bear out that the ‘investor demographic’ has for years been overpopulated by those with dad bods and cellulite.

However, since the ASX’s March nosedive, we have seen unprecedented numbers of retail (individual) investors enter the market. Inspired by the Robinhood craze across the pond, many young Australians began jumping into the market while prices were cheap (and while sports betting and RSL poker machines were off-limits due to the pandemic).

“Dirt cheap, automated on apps and championed by newbie traders who brandish their broker balances on Twitter, the stuck-at-home trading phenomenon, born in the USA, has become a global craze,” Bloomberg reported in August.

“Retail’s tentacles are everywhere. In the U.K, tax-free savings account openings at Interactive Investor jumped 238% for investors between 25 and 34 years of age in April and May. In India, newly minted day traders are crowing after falling in love with stocks that trade below 7 U.S. cents apiece and riding most of them straight up. Small-time investors in Moscow bought almost twice as many Russian shares in June than in April. In Malaysia, individual buyers are at least partially behind giant rallies in medical glove makers – one gained more than 1,600% this year. In Japan, tiny investors boosted an obscure biotech venture with seven straight years of losses by almost 11-fold on optimism for an unproven coronavirus treatment.”

Now it might be Australia’s turn. As The Australian Financial Review reported yesterday, Australia’s free-trading app boom could just be beginning.

“The founders of buy now, pay later juggernauts Zip and Afterpay are among the backers of a new low-cost Australian share trading platform that hopes to capitalise on the rush among young investors into the stock market.”

“The share-trading site – named Superhero – is set to launch on Monday and is charging a flat fee of $5 per trade with minimum investments of $100.”

“We’re making investing accessible to the younger generation,” co-founder and CEO of Superhero Mr Winters told The Australian Financial Review.

Superhero aims to challenge share trading applications like SelfWealth, which charges $9.50 per trade, and the dominant player CommSec, which charges a minimum of $19.95.

“These players have experienced enormous growth in trading volumes. SelfWealth recently reported that monthly trade volumes had increased from around 20,000 at the end of 2019 to almost 140,000 in June,” The Australian Financial Review reports.

The Reddit forum /r/AusFinance has numerous threads dedicated to the topic (including many Australians in their 20s asking the financial community for advice) reflecting young Australians’ growing interest in free trading applications and investing more generally.

From a financial literacy point of view, this is excellent: Australians taking an interest in their savings and seeking to maximise them is great. However, the craze also opens up a lot of vulnerable individuals to some painful failures.

Tweets like the following, highlighting individual stocks that have performed incredibly over the last few months, form just part of a huge rose-tinted picture many rookie investors may be exposed to on Twitter, perhaps lulling them into a false sense of security or encouraging them to take risks more experienced investors and financial advisors would steer clear of.

Twitter is also full of statements from rookie investors boasting their winnings from having a flutter on individual stocks.

While this isn’t necessarily wrong (individual stocks can help your portfolio), and while many seasoned investors may have a few well-picked individual stocks on their books, when you’re starting out investing it’s much smarter to focus on building an intelligent overall plan (read: a diverse portfolio), covering your bases and minimising your exposure (which is much easier to achieve via index funds and ETFs), rather than making bets on specific stocks (something you may get the luxury of being able to afford to do further down the line).

Even then, it’s crucial to remember the risks behind investing in individual stocks (as we like to call it, “fluttering”) – something apps like Superhero are making a much easier proposition for many young Australian professionals.

That’s not to say free trading applications are the enemy, but when you use them you should do so with your eyes open.

“When trying to get as much return as you can for the least amount of risk, your number one concern should be diversification,” according to Investopedia.

“While having low fees and managing your own tax situation is good, it is better to have adequate diversification in your portfolio. If you don’t have the funds to make this happen, an ETF or mutual fund is probably better for you – at least until you build up a solid base of stocks.”

Further information on the pros and cons of investing in single stocks can be found here.

Another good point of contact – in our view – for rookie investors, is a recent episode of The BIP Show podcast. During said episode, James Whelan, Investment Manager at VFS Group in Sydney, divulged a common error rookie investors commit: being tempted into making lots of little punts.

“You duck down to Ryan’s Bar, catch up with your mates, they say, ‘I’ve got a red hot tip for you Jimmy, you’ve got to get onto this one… they’re in Sierra Leone and they’re digging ants out of copper mines.”

“It’s just the biggest load of baloney… [but] you do a cursory look and purchase.”

“It’s the worst possible idea – you don’t know anything about it, you’re not that close to the company, it’s probably going to be a terrible idea anyway and there’s every likelihood that… on the other side of it someone is just selling into your buying.”

“If you’re not close to it, don’t even worry about it – at the small end of the scale.”

“It’s easy to keep up with what the HP’s are doing or CBA, Apple or Amazon because it’s in the news and it’s well disclosed. But the worst mistake you can make is to have a whole shoebox full of these [speculative] pieces.”

Another common faux pas is not cutting your losses, Chris Weston, head of research at Pepperstone, stated during the same podcast episode. According to Mr. Weston, understanding position sizing can help you do this.

“Everyone comes on board, they start trading FX markets or indices and all they’re focussed on is entry points.”

“[You see] signal services and all that nonsense advertised every day of the week on Youtube and it becomes completely infuriating.”

“Every time you go onto Facebook there’s a signal service trying to be pumped out – that’s not trading.”

“Getting into the market is about 10% of trading,” Mr. Weston said. More importantly: “You’ve got to get correct position sizing for the right size of your account. You’ve got to understand where your stock loss is, how much risk you’re taking, and understand what sort of reward you need to be taking from that.”

In other words: it’s not about obsessing over your win-loss ratio, but getting enough winnings from your wins (and not losing too much from your losses). In fact, some of the most successful traders have a 60% loss rate, but the amount they win vastly offsets them.

“A 40% success rate can still make you money [if you cut your losses correctly].”

Mr. Weston told The BIP Show this is a mistake he sees “time and time again” at a retail level.

According to Mr. Weston, it comes down to pure ego: [many people] have made money in property, done well in life, run a successful business, etc. [Then they] start trading…”

“Human beings have been bred to be right [so they] will start making a loss on a position and continue holding that position.”

“There’s a saying: ‘professional traders go broke taking small profits, retail traders go broke taking massive losses.’”

“That is the number one reason I see people blowing up their accounts.”

“You don’t always have to be right – the notion you can accept a [small] loss and move onto something else is what trading’s all about.”

“You need a process.”

Another smart piece of financial wisdom can be found in the r/financialindependence Reddit thread on “timing the market.” It illustrates why, though it may be boring and cliche, time in the market tends to beat timing the market.

The author of the thread claims to have downloaded the historic S&P 500 data going back 40 years, and uses it to model three different portfolios, named after three fictional friends Tiffany, Brittany and Sarah.

“All three saved $200 of their income per month for 40 years for a total of $96,000 each. But after 40 years they all ended up with different amounts based on their investment strategies.”

The findings may be fictional, but they demonstrate a valuable point.

Tiffany’s Terrible Timing

“Tiffany is the world’s worst market timing. She saves $200/month in a savings account getting 3% interest until the worst possible times. She started by saving for 8 years only to put her money in at the absolute market peak in 1987, right before Black Monday and the resulting 33% crash. But she never sold, and instead started saving her cash again, only to do the same at the next three market peaks. Each time she invested the full amount of her saved cash only to watch the market crash immediately after. Most recently she put all her money in the day before the 2007 financial crisis. She’s been saving cash ever since waiting for the next market peak.”

“With this perfectly bad market timing, Tiffany still didn’t do too bad. Her $96,000 she saved and invested over the last 40 years is now worth $663,594. Even though she invested only at each market peak, her big nest egg is thanks to the power of buying and holding. Since she never sold, her investment always recovered and flourished as the market inevitably recovered far surpassing her original entry points.”

Brittany Buys at the Bottom

“Brittany, in stark contrast to Tiffany, was omniscient. She also saved her money in a savings account earning 3% interest, but she correctly predicted the exact bottom of each of the four crashes and invested all of her saved cash on those days. Once invested, she also held her index fund while saving up for the next market crash. It can’t be overstated, how hard it is to predict the bottom of a market. In 1990 with war breaking out in the Middle East, Brittany decided to dump all her cash in when the market was only down 19%. But in 2007, the market dropped 19% and she didn’t jump in until it fell all the way down to a 56% drop, again perfectly predicting the exact moment it had no further to fall and dumped in all of her cash just in time for the recovery.”

“For this impossibly perfect market timing, Brittany Bottom was rewarded. Her $96,000 of savings has grown to $956,838 today. It’s certainly an improvement, but interesting to note that when comparing the absolute worst market timing versus the absolute best, the difference is only a 44% gain. Both Brittany and Tiffany have the vast majority of their growth thanks to buying and holding a low cost index fund.”

Slow and Steady Sarah

“Sarah was different from her friends. She didn’t try to time market peaks or valleys. She didn’t watch stock prices or listen to doomsday predictions. In fact, she only did one thing. On the day she opened her account in 1979, she set up a $200 per month auto investment in an S&P 500 index fund. Then she never looked at her account again.”

“Each month her account would automatically invest $200 more in her index fund at whatever the current price happened to be. She invested at every market peak and every market bottom. She invested the first month and the last month and every month in between. But her money never sat in a savings account earning 3% interest.”

“When Sarah Steady was ready to retire, she signed up for online access to her account (since the internet had been invented since she last looked at it). She was pleasantly surprised by what she found. Her slow and steady approach had grown her nest egg to $1,386,429. Even though she didn’t have Brittany’s impossibly perfect ability to know the bottom of the market, Sarah’s investment crushed Brittany’s by more than $400,000.”

Recap

Amount Saved/Invested: $96,000 each

Investment: Buy and hold an S&P 500 index fund

Tiffany (worst timing in the world): $663,594

Brittany (best timing in the world): $956,838

Sarah (auto invests monthly): $1,386,429

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