Thursday 12 September 2013

Are you too scared to invest? You might have missed out on huge gains and put your financial futures in jeopardy.

5 Reasons Most Investors Fail

I've been actively investing money into the market now for the past 15 years. Over that time I've morphed through a number of investing styles -- day-trading, trading based on technical analysis, long-term investing, and in the late 1990s even throwing darts. If I've learned anything over these years, it's that investing in businesses and ideas, not a stock ticker, is where the big gains are to be had.
Source: Ryan Lawler, Wikimedia Commons.
So you can imagine how quickly my jaw dropped to the floor when I revisited a study conducted by Prudential Financial in June 2011 that surveyed 1,000 people and asked them two simple questions: Do you still believe in investing, or have you lost faith in the stock market; and when are you likely to put more money into the stock market (within a year, over a year from now, or never). The answers to these questions are an absolute head-banger! 
What is your current perception of the stock market?
There are still benefits to investing
42%
I've lost faith in the market58%
Source: Prudential Financial.
When are you likely to put more money into the stock market?
Within a year
25%
Over a year from now
31%
Never
44%
Source: Prudential Financial.
Now keep in mind that when these respondents were surveyed, the stock market had already rebounded a full 100% from its lows! Based on these figures, a full 44% of respondents would have missed out on an additional 26% rally in the broad-based S&P 500 (SNPINDEX: ^GSPC  ) which is higher than the historical annual average return of the stock market. Based on the exact date of June 1, 2011, to June 1, 2012, the 31% who chose to wait a year and try to time the market would have come out slightly ahead -- but if you moved that date forward or backward by just a few days they, too, would have lost out.
Here are five reasons I've learned throughout my years of investing why most investors fail:
  • They're trying to buy stocks, not businesses.
  • They don't understand the concept of compounding gains.
  • They don't feel they have enough money to begin investing.
  • They're too scared to lose their money.
  • They don't know how to get started.
And here are some of the ways you can overcome these flaws.
Buy businesses, not stocksAt The Motley Fool you'll hear us trumpet Warren Buffett, the CEO of Berkshire Hathaway(NYSE: BRK-A  ) (NYSE: BRK-B  a lot -- but with good reason. Warren Buffett invests with the mentality that he's buying into a company that he thinks would succeed if the stock market shut down for the next 10 years. He believes in the management team of every company he buys and focuses on buying businesses with brand and pricing power. You might refer to them as boring investments, but Buffett just sees these businesses as steady sources of cash flow that will increase shareholder value in almost any economic environment.
Therefore, it shouldn't come as a surprise that his holding company, Berkshire Hathaway, which just recently announced the purchase of its 58th subsidiary in NV Energy in May, has outpaced the S&P 500 in 39 of the past 48 years. That's not luck -- that's what happens when you invest in businesses instead of trading stocks.
Invest for the long term and let compounding gains work in your favorThe most abundant mistake often made is when investors attempt to become traders and time the market. While timing the market may work for a short period, it's been shown time and again that long-term compounding gains achieved through share price appreciation and dividends will outpace the nominal gains achieved through day-trading and short-term holds. According to ABC News, and as I noted last month, of the nominal gains achieved by the S&P 500 between 1910 to 2010, dividend yield and dividend growth comprised 90% of all gains.
The Fool's Brian Stoffel put this story in an even easier-to-understand context in February 2012, when, in his fictitious short story he undertook explaining how short-minded investors would have missed out on big gains in Coca-Cola (NYSE: KO  ) versus long-term investors. Had a short-term investor sold holdings after 10 years in Brian's story, he or she may have netted a 2,500% gain, but were the same investor to hold from 1920 through the present day, that person would be up well over 1,000,000%, inclusive of dividends and share price appreciation!
There is no such thing as a wrong amount to invest withOne of the more superfluous rumors that's been floating around for decades is that it's not worth investing in the stock market if you don't have enough money to get started. This is blatantly wrong! If you have $200,000 or $200, it's always in your best interests to put that money to work for you.
Last week, the Fool's macroeconomic guru, Morgan Housel, demonstrated this point to a "T" when he examined the effect of wealth building over time. According to his calculations, a person in his or her 20s could see each dollar saved and invested turn into $10-$18 in future value. Even if that only means $20 per week, that's possibly $200-$360 in future value based on the standard historical returns of the market! 

Source: Rafael Matsunaga, Flickr.
You have to invest to beat inflationPutting your money under the mattress might preserve your nominal money, but it won't help you over the long run as prices continue to rise and make what money you currently have less valuable. Anyone who hopes to stay ahead of the game needs to invest.
Keep in mind that there are multiple ways of beating inflation and retiring well without risking your entire nest egg. It's perfectly fine to be risk-averse, which is what investment-grade and government-issued bonds are for. However, other ways of investing safely do exist, including buying into basket ETFs that spread your assets, along with the assets of others, among a number of companies. One great idea here would the iShares MSCI USA Minimum Volatility ETF (NYSEMKT: USMV  ) . Composed of 134 large-cap, low-volatility names such as PepsiCo.Johnson & Johnson, and TJ Maxx parent TJX, the iShares Minimum Volatility ETF bears just a 0.15% annual expense, yields slightly better than 2% annually, and is only 78% as volatile as the S&P 500.
Getting started is easier than everOne of the often forgotten reasons investors fail is that many are simply too overwhelmed or worried about their lack of knowledge to even get started. Luckily for you, the Internet has made the ability to learn about the market and individual companies easier than it's ever been.
The Motley Fool's co-founders (and brothers), David and Tom Gardner, developed the 13 Steps to Investing Foolishly specifically with that skittish investor in mind who's always been curious about investing in the stock market but has been terrified of his or her lack of knowledge or been wary of how to get a foot in the door. My suggestion is, if you're one of the 44% who exclaimed they'd never invest in the market again, one of the 58% who's lost faith in the market, or one of the many on the outside looking in, read over and implement these 13 steps.
Obviously you aren't going to be right with every investment, but all it takes is a few big winners and a lot of time for you to be sitting pretty in an early retirement.
Put plainly, if you don't take the time to invest, you could wind up like the millions of Americans that have waited on the sidelines since the market meltdown in 2008 and 2009, too scared to invest, that have missed out on huge gains and put their financial futures in jeopardy. 

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