If you’re a fan of cable financial news or a frequenter of cocktail parties, you’ve probably heard many great stock ideas. Some may sound very tempting. That does not change the facts – ill-informed speculating in the stock market is pretty close to Las Vegas style gambling (minus Cirque du Soleil). Here are the top reasons stock market gambling is a bad idea:
- The competition is intense. There are about $6.6 trillion dollars invested in actively managed U.S. stock mutual funds that are all trying to find the best investments. That does not include the many billions invested in high powered hedge funds also buying and selling the same stocks. Added together, it means that any stock idea you have is probably held by many other people, most of which have done more research than you and have much more sophisticated trading tools and data at their fingertips.
- Individual investors typically underperform the market as a whole. Many investors follow the same set of instructions -buy high, sell low, repeat. Numerous studies have shown that the average investor does not beat the market and can underperform it by a wide margin.
- Gambling can be a true addiction and stock trading can be a form of it. With the rapid fire nature of stock trading, the continuous up and down movements of markets, and the ability to make and lose great sums of money, stock picking can feel very similar to high-stakes casino games. Most Americans feel a small amount of gambling is fine, but once gambling or stock picking starts to interfere with one’s life or jeopardizes one’s financial stability, it can quickly cross over into danger.
- Highly-trained professional investors can be hired to manage your portfolio at reasonable costs. The average expense fees for mutual funds have come down significantly over time, moving from near 1% in 2000 to 0.7% in 2014. Spreading out your risk and tapping into the resources of a large institution is becoming easier and cheaper.
To avoid having a casino hiding in your brokerage statement, it is wise to set guidelines in advance. Set limits on the total amount you place in speculative stocks. Conservative numbers make sense-perhaps no more than a few percent of ones assets for most investors. If you are wrong about a stock and the company goes bankrupt, make sure losing that amount of money will not meaningfully impact your financial stability. For the rest of your portfolio, view stocks as they should be viewed -long-term investments that given time and properly diversified, can compound your wealth and help you reach your financial goals.
Jonathan Bernstein is a Senior Research Analyst within Hefren-Tillotson’s investment advisory group. Jonathan is a graduate of Yale College, a Chartered Financial Analyst charter holder (CFA) and a CERTIFIED FINANCIAL PLANNER certificant.