Sep 272015
 

A common fear for beginners is “what if I lose all my money?” Well friends, if you lose everything it’s entirely your own fault for betting it all on a single stock! With even a little diversification you’ll never lose ALL your money. You are more likely to lose “a lot” of money. And don’t forget that you haven’t lost a dime until you actually SELL. You can live in denial the rest of your life!

Here are a few creative ways to lose “a lot” of money:

 

1. Short Selling

Short selling is borrowing shares, selling them, and buying more to cover what you borrowed at a future date. It’s used to make money on a falling stock price. Unfortunately stocks tend to go up 70% of the time. If you buy stock, the worst that happens is that the company goes bankrupt and you lose everything. But what happens if you short the stock and the company does exceedingly well? Lets check a quick example:

  1. Short 100 shares at $10 – You put $1000 in your pocket
  2. Company discovers elixir of eternal life, stock price jumps to $100,000/share
  3. To cover those 100 borrowed shares, you now owe $10,000,000 (100 x 100,000)
  4. Total loss -$99,999,000

As you can see the loss is theoretically infinite, instead of only losing your initial investment in the case of stocks. In the case above a good scenario would be the stock dropping to $5 in step 3. You’d get to keep $500.

How to avoid: Don’t short sell. Remember that stocks go up 70% of the time.

 

2. Your ETF/Mutual Fund gets shut down

Your ETF/MuFu provider thinks “no one is buying my toilet store index” and they announce the fund is shutting down. There is a good chance you are in it for the long haul and weren’t planning on selling for years, people always need toilets! And you are too busy solving the problems of the world to pay attention and you miss the announcement. You also miss how the ETF price has been steadily dropping for the last month and you’re position is down 40%.

The ETF liquidates all shares and deposits the cash in your account. Against your will you just solidified that 40% loss! Luckily there is another toilet ETF that also dropped 40% and you can just take your scraps and pump them in the competitors fund…. Just kidding! You’re busy sailing around the world or something and the toilet index recovers entirely while your cash just sits there.

He had to be shot

How did my horse ETF do? – He had to be shot

How to avoid: Keep an eye on obscure index funds and check your mail. Avoid crappy funds. If your fund dies, put that money right back into an identical fund. If it’s in a taxable account the government will even give you a tax break to soften the blow.

 

3. Buying penny stocks

Penny stocks are full of scams. The most notable is the “pump and dump” where the scammers will buy the stock at its low penny price, advertise the stock with exaggerated false claims and straight up lies, sell their positions, and leave you with a massive loss.

Roulette

Penny stocks are like playing roulette, sure after 36 tries you might find one where you hit it big, but after losing money on the past 35 you are still deeply in the red.

How to avoid: Don’t buy them. Unless you have met the CEO and believe in the company.

 

4. Acting on your greedy impulses or friend’s stock tip

Whoa! That penny stock I had my eye on just went up 20% in one day! But I’m going to listen to point #3 and not buy it…….. Oh wow it went up another 10% the next day! I’m missing out! It’s probably going to keep going up another 10% every day so I’ll buy it now!

Naturally the stock drops 30% the following day.

Credit: Carl Richards - The Behavior Gap

Credit: Carl Richards – The Behavior Gap

Buy low sell high sounds so easy, yet most beginner investors will make this mistake at some point. Unless you can see the future you never know where the top or bottom of that curve is and it’s a fools game to try.

How to avoid: Do nothing when you see massive gains or losses. Stick with a “buy and hold” strategy, even if you lose 30% 2 days after buying a stock.


If you thought there was a personal touch on the 4 options above you are right. I’ve lost money on all these lousy concepts. I’m just glad I didn’t have much invested and sowed my wild investing oats early. Remember, smart investing is boring, and fun investing, like points #1 and #3, are fun ways to lose money.

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