Good topic umop3pisdn, my first recollection of rookie investing mistakes was not checking ex-div dates when buying shares in companies that were about to pay a large dividend, thinking I was getting a bargain and then realising I was NOT entitled to the dividend, hence the share price fall that day. Another big one is following hot stock tips on sure things. I have learned that if it looks or sounds too good to be true, it usually is. There is always a catch, and if you haven't worked out what it is, you probably haven't looked hard enough or in the right places.
Another one is the 45-day rule, where you are not entitled to the franking credits attached to a dividend unless you hold the underlying shares for a minimum of 45 calendar days - not including the days on which you bought and sold the shares. If you don't satisfy the 45 day rule (also known as the Holding Period Rule) you have to manually adjust the franking credits that you claim on your tax return as the dividend will be treated as an unfranked dividend, and a LIFO rule also applies when calculating that - as explained here. However there is a "Small Shareholder Exemption" that applies to the 45 day rule that allows people who received total franking credits that are valued at less than $5,000 for the financial year to claim their franking credits in their tax returns even when they may not have held the shares at risk for 45 days - as explained here.
Another trap for new players is the 50% CGT discount for assets held for 12 months. If you're about to sell shares at a good profit and it's coming up for 12 months since you bought them, it's usually worth considering waiting for that 12 month anniversary to pass before you sell, or else you're going to pay CGT on 100% of your profit instead of only half of your profit. That will also depend on whether you have capital losses to offset against capital gains, so it's not always a straightforward decision. Share prices can also decline while you wait, so the chance of that happening is also a risk worth considering.
I guess the biggest mistake people make is lack of DD when buying shares, and/or not concentrating enough on the price. In the case of DD (due diligence, i.e. research), it should be verified from multiple sources ideally, rather than relying on a single source, particularly if that source is the company itself. Companies will almost always paint their own situation and future prospects in the best possible light, and all bad news and significant risks will often either be ignored, glossed over, or have plenty of positive spin applied to them. Likewise management and directors buying shares on-market or participating in a CR is not necessarily a strong indication that the company is currently trading at a bargain price, or that it has a bright future. While it is true that company insiders do have a depth and breadth of knowledge that is often unsurpassed in terms of knowing their own company and where it sits within their own industry, and its realistic future prospects, it is also true that insiders can be swept up in a positive company culture that accentuates the positives and tends to mostly ignore the negatives. They often do not see their competitors creeping up behind them because they are swept up in the excitement of what they are doing. It is often worth considering the perspective of people who are experts on the industry in which that company operates but are not directly associated with the company itself. The trouble with that is trying to determine which industry analysts are truly giving honest arms-length opinions, and which ones have vested interests in certain players doing well and others not so much. It can be tough. However, as a general rule, the more sources you can find that agree on something, the more likely it is to be true. Certainly it is always worth trying to independently verify information that has been received from a single source.
It's also important to realise that if a company is of a decent size with a decent profile and they have enough industry eyes on them, and all of the information out there is agreed upon, it is more likely to be in the current share price, so there is less likely to be an opportunity there. I'm not a proponent of the efficient market hypothesis by any stretch, however I do think things are more likely to be priced in with larger companies than with smaller ones simply because of the number of analysts following those companies and the fact that if there was a big enough opportunity there would already be large players trying to arbitrage that difference between valuation and price.
But not always. Sometimes the baby gets thrown out with the bathwater. Sometimes people think that anything to do with online shopping and hand sanitisers or air purifiers are a screaming buy when we're at the start of a global pandemic, and sometimes people decide all of those same companies are strong sells when the first vaccine is announced. That is to say that the market does tend to overreact (and overshoot) in both directions at times. But I still tend to think the larger mispricing opportunities tend to be at the smaller end of the market where there are less analysts actively following those companies.
Other pitfalls:
- Anchoring. Don't anchor on your purchase price or where the company's share price has been in the past. Neither matter to where the share price is going in the future. If in doubt ask yourself if you would buy the shares today at the current price knowing what you know now. If the answer is no, then continuing to hold them might NOT be the best idea. There is opportunity costs in anchoring, as well as the risks of increasing losses. If you're underwater on a position you do not have to make the money back in the same stock that you lost it in, you can use what's left to generate better returns elsewhere.
- Jumping at shadows. Be prepared to sell quickly if new facts emerge that indicate that your investment thesis is flawed, but don't be shaken out of a good position by share price movements or market sentiment.
- Not letting your winners run. That can be a mistake. Let your winners run. While it's good to manage position sizes with an eye on risks, it's often good to stay exposed to companies whose share price continues to rise at a good clip, even when you think they're looking expensive and overpriced. They can continue to rise LONG after you think they should not. By all means trim and trim again, but keep some exposure, for instance if you invest $20K in a company and it doubles its share price, perhaps take $10K to $20K off the table - so leave $20K to $30K on the table, and just keep doing that every time they double. I have lost a lot of money over the years by fully exiting my winners far too early.
- Getting caught up in a story. Play the percentages. This one especially applies to mining exploration companies and early stage biotech companies. Know that the vast majority of these companies never make any money for their shareholders, after burning through many millions of dollars of shareholder funds. There are always stories about the lucky "investors" (punters) who jumped on the companies that actually made it and went up by 100x or more, but for every one of those stories there are 20 or 30 (or more) stories that aren't so easily told, about losing 100% of their "investment" when the company "suddenly" went into receivorship or called in the administrators. If you are going to back one of these companies, do as much work as you can to understand the risks and the potential rewards, and only invest what you can afford to lose 100% of. But also be aware that even with all of that work, you still only know a very small percentage of what the company's own board and management know, and even they do not know if they are going to make it or not. They hope they will. They may strongly believe that they will. But they certainly do not know that they will, because they don't know everything they need to know to accurately ascertain that. The events that will determine that outcome have yet to occur. And that's why the vast majority of fund managers won't even look at those companies, because it's like throwing a dart at a dart board in a pitch black room. It's what they often call a binary outcome. Heads they make it. Tails they don't. Only the chances are not 50/50. The chances are heavily weighted in favour of tails. And it usually takes many, many years to determine that outcome.
- Falling in love with a company. There are a handful of companies that I love. But I am not IN love with them. I don't have rose coloured glasses on. If they are unfaithful, I will not pretend it didn't happen and look the other way because I don't know how I'd survive without them. Owning company shares is sort of like a marriage. There is a lot of trust involved. However it only tends to go one way. They usually don't care too much about you. And it's more like a pre-1890 Morman marriage, where you are the man and the company is one of many wives, with the added bonus that you can swap wives whenever you like, as there is usually a steady stream of others trying to offload theirs at various prices. So really not much like a marriage at all. It's OK to admire a company you hold shares in, to want to defend them publically, to want to sing their praises to others, but always be prepared to examine fresh information exactly like Spock would, coldly, dispassionately, logically and with an unbiased mindset. As much as humanly possible. Because Spock was clearly not human. Just be prepared to accept that (a) you could be wrong, (b) things change, and (c) the company might not be the best place to invest those dollars any longer despite how well (or not) they've done in the past.
- Don't take criticism of your investment thesis personally. Anyone looking to punch some holes in your thesis is actually doing you a huge favour. There are many successful investors who say if they can't identify a good bear case, then they won't buy stock in a company. They need to see the good side and the bad side and then come to the conclusion that the positives outweigh the negatives and the company is still a good investment at the price that it is available at despite the identified risks. What's worse is not identifying the risks and then having one of those "come out of left field" to shatter your investment case after you've sunk significant dollars into the company. Identifying the downside, including the obvious and the not-so-obvious risks to the investment are critical to understanding (a) whether you should proceed with the investment, (b) how much you should invest (position weighting, with regard to risk management) and (c) things to keep a close eye on that could signal a hasty exit would be a wise move.
- Risk Management. This one could take hours, but it won't. This time. So on this occasion I'll just mention risk management in terms of diversification vs concentration. Very concentrated portfolios can be very profitable when you have mostly winners, and little to no losers, but if you have 2 or 3 big losers in a portfolio of only 5 companies, that can be very material. Likewise if you hold 50 companies with equal position sizes (each position has roughly the same market value) and one has a share price that doubles, you may hardly notice any change to your total portfolio value because it would only represent a 2% increase. That would be diworsification. Making your returns worse by holding too many positions. Likewise, having the majority of your positions in a single industry is asking for trouble. Try to spread your investments across a few different sectors that are not directly correlated to each other. You can also diversify across asset classes, but personally I stick with sharemarket investing because (a) I understand it best, and (b) I think that this is where the best returns are over the long term (as well as the medium term and often the short term). Also, be aware that there is SO much more to risk management than diversification, but we all got to sleep, and it's getting on for midnight here.
P.S. Love to know how you came up with that user name umop3pisdn, or at least a hint. It sounds like it came from a random passsword generator.