Imagine working your socks off in your 9am – 9pm job, and then suddenly, you hear news that a colleague of yours just bought a shiny new car after making big bucks in the stock market.
Having had enough of slogging away for what seems like an eternity and never being able to afford the luxuries of life, you want to know how he did it.
Luckily, your colleague is in high spirits and wouldn’t mind sharing some stock tips with you – like how to flip some stocks for quick money.
Wary, you put in only some savings you don’t mind losing to give it a shot.
You start to make 30-50% on these “investments” but the profits are too insignificant because of the minimal capital you put in.
Emboldened by your handsome profits, you decided to plough in your hard-earned savings, hoping that it’s your magic ticket out of the rat race.
However, things started to turn for the worse.
Your stocks’ prices begin to go down but you tell yourself “it’s only a temporary downturn. I’m in it for the long run”.
And they continue to go down while you hold onto the stocks until despair kicks in. Eventually, you threw in the towel and sell off right at the bottom of the cycle – at maximum pessimism.
Pretty sure it will not happen to you?
Well… it happened to our renowned scientist – Sir Isaac Newton.
Historic Investing Lesson: How Sir Isaac Newton Burned His Fingers
Astonishingly, although Isaac Newton is good with his scientific theories, he had his misadventures with stocks too.
During the 1700s when stock exchanges were just set up, there were a few trending stocks namely East India Co., Bank of England and South Sea Co.
Isaac Newton dabbled in the South Sea Co. shares after getting to know his friends were making good money in the stock. Sensing that the market was getting out of hand, he exited with a 100% return within a few months.
However, hearing that his friends are still getting richer, he was lured into the exuberance and jumped back into the stock at a much higher price. Needless to say, the bubble burst thereafter and Isaac Newton ended up burning his fingers badly.
Exasperated and despaired, Isaac Newton is known to have said
“I can calculate the motions of the heavenly bodies, but not the madness of people“Sir Issac Newtron
In essence, the anecdote itself teaches us that stock tips is a dangerous thing and one should always do your own due diligence.
With that, here are five reasons why stock tips will never work.
1. It’s Usually Too Late
The market cycle and corresponding flow of the news works in a way such that it reaches the retail investor at the last moment.
This is what happens: the company insiders get the knowledge first hand, then the big fund managers followed by the vigilant gurus, and then you.
By the time the news of a good stock or a bad one reaches the small guy, it’s too late to invest or to get out. This is why small investors are the ones most likely to lose money on either of the bull or bear cycle.
This is also probably the reason why they often buy high, sell low instead.
2. One Size Does Not Fit All
There’s a saying in the market – one size does not fit all.
While your friend’s investment picks might suit him perfectly, they may not make the cut for you.
Because both of you have different personalities, different risk tolerances and lastly, different family situations.
Think about it, a young, single high-flyer can considerably have much higher risk tolerance and long holding durations compared to another older person who now depends on this retirement funds to sustain his current lifestyle.
3. Validation is like Opium
One recent mistake I made is to invest in AEM Holdings near its peak because of FOMO (fear of missing out).
I first came to know about AEM Holdings (SGX: AWX) from a stocks’ trading social media platform called InvestingNote after people were talking about their double-digit gains from this stock meteoric rise. At the same time, I also start to see a few analysts publishing their reports on the company.
Intrigued, I went to do my own research on the stock but it wasn’t easy because of their business model. Meanwhile, the share price kept rising and more people are saying that it has much more room to grow.
Afraid of missing out, I quickly invested in the stock only to have the company issue weak guidance in the year ahead as their ‘test-handling’ business comes to the end of the cycle with Intel.
Hence, AEM Holdings’ share price plunged subsequently and I have only myself to blame for succumbing to confirmation bias – a type of cognitive bias that involves favouring information that confirms your previously existing beliefs or biases.
Lesson: You should always do your own due diligence irrespective of all the positive stuff you hear surrounding the company. It is even better if you can find opposing views to weigh out the risks involved too.
4. Not All are Well-wishers
In my opinion, a ‘friend’ these days can be over-rated because some stranger can just add you on Facebook and he will turn out to be your ‘friend’ without even meeting you!
Jokes aside, a ‘friend’ may sometimes try to wreck some havoc in your investment plans because he is envious of all the successes you have already achieved.
Another example is when your egoistic ‘friend’ just wants to brag about all his winning stock picks and gave you casual but detrimental stock tips.
As a matter of fact, it is advisable to take your “friends” stock tips with a pinch of salt.
5. Investing Is A Single Player Game
According to legendary investor Mohnish Pabrai and many other popular stock investors, investment is not a team sport, it’s a single player game.
In his Ten commandments of investment management, the second commandment says this:
“Thou shall not have an investment team”.Mohnish Pabrai, Author of Mosaic: Perspectives on Investing.
To further explain this, everyone has diverse circumstances and circle of competences.
When investors work in a team, stock tips can lead to blame games and cause more harm than good.
One example is when you try to hold on a winning stock but your friend starts to say that it has already reached the target price and at dangerous levels.
These personal feelings are likely to throw you off your game, and that’s when you start to lose, especially when your emotions or even friendships conflict with your rational thinking required for investments.
To wrap up, it is not wrong to get stock ideas/tips from friends.
However, it is vital to take such advice with a grain of salt and do your own due diligence. It is pointless to play the blame game later on if things go south because you are ultimately responsible for your own financial decisions.
If you wish to ask for opinions on investing in something, you can always join our Ask Dr Wealth facebook group. More information should allow you to at least make a better decision, provided you practise good decision making and are aware of your own biases.
Alternatively, if you want to learn how we invest, go ahead and click here to learn how.