Coronavirus and the associated market crash in March saw thousands of Australians jump into the stock market, earning themselves a warning from the investment watchdog about the dangers of trying to time the market.
According to investment expert and founder of Stockspot Chris Brycki, the Australian Securities and Investments Commission (ASIC) warning highlights the one rule investors should live by.
“The risk of making money in the short-term for anyone is you tend to attribute that profit to your skill, as opposed to just getting lucky once,” Brycki told Yahoo Finance.
“Just as if you go to the casino, it’s possible to win on the blackjack table without any experience, but that doesn’t mean it’s repeatable.”
Instead, the “best thing” investors can learn is just how little they know.
“It’s very hard to learn that quickly because of the Dunning Kruger effect.”
The Dunning Kruger effect is a form of cognitive bias which sees people with a low ability overestimate their ability. They do this because they perceive the small amount of knowledge they do have as being significantly greater than it is, as they’re comparing themselves to a former version of themself who knew nothing.
Brycki said this cognitive bias is difficult to overcome, and coupled with first-time investors general lack of knowledge, can be particularly devastating financially.
“Unfortunately it often takes losing money to really appreciate that because of the learning curve. So because of that, I'd say start really small. Losing money is for a lot of people a great way to learn, so starting small is a way of doing that that's not going to harm your future or family finances,” he said.
Between 40 per cent and 50 per cent of Stockspot clients have been drip-feeding money into the stock market for the last three years, earning between 8.4 per cent to 9.2 per cent p.a.
At the same time, analysis by ASIC and the UK financial regulator FCA found that between 73 per cent and 78 per cent of day-traders will lose money, which is why Brycki advocates investing more broadly.
And he’s not alone - even Warren Buffett, who is considered the world’s best investor - believes average investors would be better off investing across an index, rather than trying their hand at stock picking or timing the market.
Stockspot’s philosophy is that a diversified portfolio coupled with patience is the secret to investment success.
“What’s really important that people understand is that the market is made up of hundreds and hundreds of stocks, but actually there have been a couple of studies - including one by JP Morgan - that have looked at all of the stocks listed on the stock market since the 1800s, and basically found that only 4 per cent of them have driven all of the returns in the market,” Brycki said.
“So only if you’re owning those 4 per cent are you making a good return. The challenge then is - are you one of the tiny group of people who can pick those stocks?”
If you’re not and you’re trying your hand at stock picking, you’re likely owning shares that are doing little more for your finances than if you’d kept your money in the bank.
“You really do need to spread it across everything.”