The sensible way to hedge that risk is diversification. That means buying stocks in many, many companies, including companies of different sizes, in different industries and in different countries. That’s prohibitively expensive for most individual investors, which is why mutual funds and exchange-traded funds are a better bet.
THERE’S NO SUCH THING AS A FREE TRADE
Another way to grow wealth is to minimize investing costs. That means trading less, not more, because trading incurs costs even when there are no commissions involved.
Investments held more than a year benefit from favorable capital gains tax rates, for example. Those held less than a year are taxed as income if the trade wasn’t made in a tax-deferred account such as an IRA.
Another way cost is incurred is in what’s known as the bid/ask spread. The banks and financial institutions that facilitate trading in various stocks are called market makers. They offer to sell stocks at a certain price (the ask price) and will purchase at a slightly lower price (the bid price). People who trade stocks instantly lose a little money on each transaction because of this difference. That’s not a big deal for infrequent traders, but the costs add up if you churn stocks in and out of your portfolio.
The biggest potential cost, though, is that every trade exposes your portfolio to the many ways we humans have of screwing up our money. We’re loss-averse and we want to avoid regret, so we hang on to losing stocks. We think that we can predict the future or that it will reflect the recent past, when this year should have taught us that we can’t and it won’t.
We also think we know more than we do, a cognitive bias known as overconfidence. If you’re determined to trade, or day trade, don’t gamble more than you can afford to lose, because you almost certainly will.