7 Reasons Why Most People Lose Money on the Stock Market

Data shows that between 70% and 90% of retail investors lose money on the stock market, despite the market generally going up over time. Why does this happen, and how can you avoid making the most typical mistakes behind this? In this post, I will explain how to avoid the pitfalls and set you up for a lower risk of losing money.

The good and the bad stories

The stock market is filled with success stories of people like Warren Buffett, George Soros, and Jesse Livermore, who made fortunes on the stock market. Occasionally you might also hear your friends, neighbours or colleagues bragging about successful investments with high returns.

On the other side, we hear the disaster stories about people who have to sell the house or end up going completely broke because of "bad luck" on the stock market. But in between the success and the disaster stories, there's a huge amount of retail investors who lose money (small or large amounts) and rarely talk about it, because they are ashamed.

The surprising truth is that even though the stock market as a whole goes up over time, various sources state that somewhere between 70% and 90% of all retail investors lose money on their stock investing. Why is that? The following is a rundown of the most common reasons.

1. Choosing high-risk stocks

It's quite common for beginners on the stock market to be attracted by stocks with a seemingly high-risk/high-reward profile. Typically this refers to small growth companies with promising concepts and blue sky prospects. Wouldn't it be more exciting to own a stock that may potentially multiply its value by 10 or 20 within a few years than some boring old household name stock?

The problem is that the vast majority of these promising small growth stocks never materialize to their potential. Actually, research shows that small-cap growth stocks have been the worst group of stocks to own over the last 100 years. They have on average returned just about 0% annually compared to the ~8% for the rest of the market. I have written another post on how small-cap value stocks have performed remarkably better than their growth peers.

2. Buying because someone said it would go up

The number one reason for retail investors losing money is blindly following other people's recommendations. People tend to take advice from all kinds of sources:

• Your friend who happens to work at a company she believes has a bright future
• Your colleague who bought a product from a company and believes everyone should own it
• Your taxi driver who heard a rumor that some stock is going to skyrocket
• Your bank advisor who recommends buying stocks in the bank

Even professional stock market analysts can't get stock picking right, so why should you even consider the sources above without doing your own research and follow your own strategy?

We tend to have faith in people we like, but when it comes to financial decisions, they may not always be the best advisors. Even if they have a great track record or seem to know what they're doing, you should always follow your own strategy and do your own research.

3. Short-term investing

Many people have a dream of getting rich quickly and this is actually possible on the stock market. The only issue is you have to make very risky bets AND be extremely lucky to achieve this.

Experienced investors know that short-term stock investing is a loser's game. The extreme form of short-term trading is day trading, where you hold stocks for hours, minutes, or even just seconds. Only a very small minority of people with very special psychological skills are able to make money on this - most people go broke down the road.

Reality shows the longer you hold on to stock investments, the larger the probability that you will see a nice return.

4. Lack of diversification

A famous investing quote by Nobel Prize winner Harry Markovitz says:

"Diversification is the only free lunch in investing."

Diversification is the opposite of putting all your eggs in one basket. It's about spreading your risk across multiple assets. If some of them go down, hopefully, others will go up and balance out the losses.

Index investing is becoming increasingly popular, and for good reason. It brings diversification out of the box. However, still lots of retail investors believe this is too boring, and instead, they may be tempted to invest all their money into one (or a few) stock(s). This results in a very concentrated portfolio with a very high risk.

My advice is to either do index investing or to invest in 15 or more companies from different sectors. Personally, I do a combination of the two.

5. Fear of missing out

The term FOMO (Fear Of Missing Out) caught traction during the post-pandemic rally in 2020-2021, where the stock market in general and tech stocks in particular experienced huge gains. FOMO refers to the fear of being on the sideline while watching others earn truckloads of money.

The problem is that the feeling of FOMO typically hits the hardest just around the time when a stock (or the whole market) tops. The bigger the momentum and the larger the recent gain, the more people will be hit by FOMO. An example of this was the huge inflow of money into Cathie Wood's ARK Innovation fund just around the time when it topped in late 2021.

6. Selling in panic

Another common way to lose money is to not have control over your emotions and sell stocks in a panic. This happens to a lot of people when stocks are falling at a high pace day after day. It feels so bad and our brain just wants us to make it stop. The simple solution is to sell the stocks, and we will not experience any more losses. Sound like a sensible solution?

Unfortunately, the times when stocks have been falling dramatically tend to be the worst times to sell. Actually, more often than not, these scenarios are great times to buy if you are a long-term investor.

Selling in panic is also a result of not having (or not following) a strategy. Which leads me to the final point...

7. Not having a strategy

You've probably heard it before. As an investor, you need to have a strategy and to follow it. So, what is a strategy? A strategy defines how, when, and what you buy and sell on the market. Here are a few questions you can ask yourself to get started with a strategy:

• What is my risk profile? How much can I afford to lose?
• What is my time horizon? Am I a buy-and-hold investor, or do I plan to sell?
• What kind of stocks, funds, bonds etc. do I invest in?
• How much money do I allocate to each investment?
• How do I react if the market crashes?

Having answers to these questions will make it a lot easier to avoid stupid decisions made in panic.

Conclusion

If you can avoid the 7 most common pitfalls listed in this post, you're already on your way to do better than the average retail investor. After all, it's not difficult to make money on the stock market. It's much more difficult to avoid all the stupid mistakes that cause us losses.

If you want to know more about the psychological biases that trick us into bad decisions, you may want to read this post.