Fear of missing out
When was the last time you thought, gee that miner is doing well, maybe I’ll sell some of my bank shares to buy a few of its shares?
Chances are it’s something you think of frequently, as we investors constantly battle the devil on our shoulder telling us that this one is it, the next big thing. Millennials have put an acronym to it - FOMO. Fear of missing out.
The benefit of trading in and out of shares and trying to chase a winner rarely makes up for the risks involved and the returns you may miss if you don’t stick with your investments for the long term.
In this article, we talk about this kind of in-and-out trading in terms of shares but it applies to all types of investments.
Trading costs
To understand the ‘real’ cost of investing in shares, it’s helpful if you think of it much the same as other investment decisions, like buying a house.
When you buy a house you are responsible for paying for stamp duty, property inspections, legal costs, even moving costs and lots of other incidentals. It’s not something you want to do often.
When you buy shares it’s much the same, you are hit with a range of costs:
- Trading fees;
- Capital gains tax on any profits made (unless you sold them in pension phase);
- Income tax on dividends.
Don’t let this scare you off them! But it is important to take note that the more often you trade the higher the costs.
Opportunity costs
When you have a choice between two options to make there is a risk that you could get more out of one of the options - this is called ‘the opportunity cost’.
If you sell a share that you have held for two months because it not living up to your expectations, and then buy a company you think might do better, your risks are potentially four-fold:
- You could lose any gains you made on the stock while you had it, by not letting it get back to at least the price you purchased it for;
- You could lose any potential gains that it is still yet to make, had you held it for longer;
- You will be hit with trading fees again for the new stock you are purchasing;
- You will likely miss out on dividends. What if you bought a company predominantly because the dividend yield was attractive?
If you sell a stock because it isn’t as attractive to you anymore, or something else looks more appealing, you might be losing the benefits of the initial investment - not to mention what the compounding reinvested dividends would add to your return.
How to steer clear of this move
To avoid incurring the costs of moving in and out of the sharemarket too frequently it's pretty straightforward. Have a plan and stick to it. Have a certain amount of money set aside for your investments - and once invested have a plan for when you think you might exit them.
Your exit plan might include points like:
- Do you have any new information that warrants selling the share? Not because it has gone down for a few months or that another company has a higher projected price, but something significant has shifted the future outlook, or management has done something dodgy;
- Is the company doing something that’s against your value system? Like begun investing in tobacco companies or coal?
- Has a particular stock become overweight in your portfolio causing it to not be as diversified as you wish?
There will be times when you decide it’s appropriate to take what you have in one company (whether it is at a profit or loss) and invest it in another opportunity. But it all comes down to justifying the costs of an opportunity - compared to others.
You might hear that buy and hold for the long term is no longer relevant because with all the info and trading tools readily available you know so much more about a company than ever before. Rest assured somebody always knows more than you do. Let them play the short game. Most investors are better of focussing on the long game: this gives you a much better chance of capturing a return that you are comfortable with.
So, when thinking about your next investment think of the exact money you have to do it. Now ask yourself: will I need this money in the next five years? If the answer is yes - keep it in a high-interest savings account.
And the next time you have FOMO, think about your future - what type of retirement will you be missing out on?
