Stock Market Failures: 3 Reasons Why Most Retail Investors Fail

Today, why a discussion about the stock market failures is required? Today is 7-Sep-2021, and the Sensex has touched its all-time high of 58,500 points. Since the COVID crash of 2020, it rose from the lows of 27,600 to 58,500. The fall of Sensex was steep but the rise is more phenomenal. I’m sure people are enjoying this roller coaster ride. Bit it is not the way the stock market behaves all the time.

The stories related to stock market failures are more common. In reality, less than 1% of all investors can make wealth in the stock market. Particularly for retail investors, getting wealthy from stock investments is almost absent.

In this article, we will read about three reasons for failure. It’ll explain why most retail investors fail to benefit from the stock market phenomenon.

Between Jan’2001 and Sep’2021, Infosys’s stock rose from Rs.104 to Rs.1708. At this growth rate, Rs.1 lakhs invested in Infosys would become Rs.3.15 crores by Sep’21. [P.Note: I’ve considered price appreciation and bonus shares issued to the shareholders during this period.]

There are more examples like Infosys. We can question if the process of becoming wealthy is so certain, why do most retail investors fail to grab it? There are three (3) main reasons for stock market failures. Let’s discuss them here:

Reason #1. Several Unbearable Moments of Volatility

We think that we know about short-term volatility, and hence we will manage it when it comes. But it is a lot tougher to practice. It is so tough that almost 99% of all investors fail to handle it.

Let me explain it to you with an example.

Imagine yourself investing Rs.1,00,000 in Infosys in Jan’2001. It was the time when investors were putting money into IT companies (dot-com bubble). You also did it with the hope of stellar future growth.

But within the first nine months of your investing, the value of your investment fell by 65%. It means your Rs.1,00,000 becoming Rs.35,000 in less than a year. What to do in such a situation?

Almost 99% of investors cannot digest this kind of price fall in the first few months of investing.

What is also critical is not only the quantum of the fall but also the duration. How?

For example, suppose there is a price fall of 50% in 2-3 days, and soon it bounces back. In such a case, most people can stomach the price movement. The bigger problem is when it continues to fall day after day. 

Example #2

Let’s see another current real-life example of Yes Bank’s Price. It fell from Rs.275 to Rs.11 in 28 months. I’m sure most people who bought Yes Bank in 2019 would have sold this stock by now.

Rs.1,00,000 invested in Mar’19 would have become Rs.4,000 in next 28 months. Selling sounds more reasonable. Why? Because as of today (Sep’2021), for we retail investors, it is not clear if Yes Bank would come out of the peril. With so much negative news floating in the air about the weak banks, selling is most relieving.

Example #3

Even worse is the condition of Vodofone Idea investors. The price fall is continuing for the last 5.5 years. The trigger was the retrospective tax rule.

Let’s come back to Infosys. Check the above Infosys’s price chart once more. There are five (5) more instances where the stock price fell between 21% to 50%. The periods of the falling prices were five months to 18 months.

Such an extended period of falling price movements is one of the biggest causes of stock market failures.

How to deal with it?

The first rule says not to sell during times of falling prices. Why? Because no fall is permanent, the price rise is imminent. If you desperately want to sell, which is not advisable, wait for the jumps (like 10% or more). It will substantially lower the potential losses.

Moreover, read the following two reasons. It will give further insights into how to hold our stock longer, irrespective of price falls.

Reason #2. Buying Low-Quality Expensive Stocks

Apart from not being able to stay invested for long, people often see failure as they bought bad stocks. Let’s know more about it.

It is important to stay invested for the long term. But what gives the propensity to hold is as critical. People tend to hold on to their stocks longer if their underlying company has a strong business. 

Moreover, if those shares are bought at an undervalued price, the inclination to hold becomes even stronger. Read: about value investing.

Consider the example of Infosys shown above. An investor who bought its stocks in Jan’01 will see its price sink by 65% in the first nine months itself. Because it is happening in the first few months, holding on to such shares looks next to impossible if his belief in Infosys is not strong.

We can ask, what triggers such massive drops? Generally, the falls happen when the company turns out to be a Kingfisher, Yes Bank, Vodafone, Jet Airways, DHFL, Essar Steel, etc.

What is common among these companies?

They all went on from being a Blue Chip Company to bankruptcy. But it happened gradually, so people with knowledge of solvency and liquidity could have preempted the aftermath.

These examples of low-quality businesses running behind the big brand names are familiar. Retail investors often fall into these traps. It is one of the primary reasons why most retail investors fail in the stock market.

How to deal with it?

Experts advise people to learn the process of price valuation of stocks. Price valuation has its roots in the concept of intrinsic value. What’s the importance? It helps people to buy stocks at a discounted price. This way, the investors maintain a margin of safety. Thereby the risk of dramatic price falls, like -65%, can be avoided.

People who buy stocks upon analysis tend to hold on to them longer. Why? Because they are aware that the stocks they are holding belong to a fundamentally strong company. Moreover, stocks of a strong business bought at a discounted price will surely bounce back after falls.

Unfortunately, the majority of people who invest in stocks do little price valuation before buying them. People who can do some price valuation rely too heavily on the P/E ratio alone. But it is advisable to do a more detailed stock analysis. If one wants to do it, a simple excel sheet can do the job.

Reason #3. Not Diversifying Enough

Suppose you bought only Infosys’s stocks in Jan’01 worth Rs.1,00,000. In the next nine months (by Sep’01), its value fell to Rs.35,000. The chances of you selling your stocks even at a loss are high.

But suppose you bought four stocks worth Rs.1,00,000 on Jan’01. So now, instead of being fully exposed to a company (Infosys), you have a portfolio of multiple shares. The performance of this portfolio is shown in the below table:

In the period between Jan’01 and Sep’01, the value of the portfolio was -41%. It is slightly better than -65% of Infosys.

Moreover, seeing the price of all stocks going down at a tandem gives another hint. The problem is not about a company, the whole market might be hurting. You will remember, back in the Yr-2000-01, it was the time of dot-com crash.

What is the point?

Combine the Reason #2 and Reason #3. What will it do? It tells us to buy multiple stocks of quality companies at undervalued price levels. Read more about building a winning stock portfolio.

When a person is sure about the fundamentals of a company, he will hold longer. He will hold on to its stock even during the biggest stock market crashes. How? Because in these times, they’ll focus on buying more of these stocks instead of selling.

Conclusion

Stock market failures are common, and above are the three (3) reasons for it. Why most retail investors fail in equity investing has been explained. What is the purpose? If we know the reasons for failure, we can take suitable actions to avoid them.

The takeaway from this article is a critical realization. To profit from investing, it is essential to buy quality stocks at a discounted price. Once such shares are purchased, the key is to hold them even when short-term prices remain very volatile. 

Be a long-term investor. Have a happy investing.