Why investors lose money?

Roller Coaster

16 Mar Why investors lose money?

I found that many people misunderstood risks or underestimated their tolerance for risks. Hence, I always want to share the ultimate reason why people lose money in the financial markets. It can be stocks, properties or any asset class. The reason is the same – they buy high and sell low.

Buy high and sell low

While we all know that to make money is to buy low and sell high, most investors do the opposite without realising. For example, very few people were interested in the property market in 2004 or 2005. As prices went up in 2007 and even more so in 2012, investors started to pour their savings into properties. Is this buying low and selling high? To them, this is entirely rational as they share their reasons for buying a property now (although research have shown that we decide first and reason later):

  1. Property prices go up forever
  2. Singapore is a tiny country with very little supply of land
  3. Government has indicated to grow our population with immigrants
  4. Rich Chinese and massive liquidity from U.S. are going to push up the prices
  5. I am buying for my children because they won’t be able to afford a house in the future.

They believe you are a fool if you are not buying properties. It is amazing to see many Singaporeans sharing a common insight into the future. It is as if they had gazed through the same crystal ball which I didn’t get to peer. I am not sure how the future would unfold. Property prices can go either direction. But what I do know is that I sense “irrational exuberance” in the property market now. The risks have definitely increased. Looking at the newspapers I see countless property launches, courses, advertisements, etc. I think this is too much and good times do not last forever. I remember vividly that the property prices crashed after peaking in 1996 and it took 12 years to recover to the same price in 2008. People will say “this time is different” and Sir John Templeton advised that these are the four most expensive words in the English Language. I believe markets have cycles and history will repeat.

Property Chart

Singapore Property Price Chart – 12 years for prices to recover from 1996 peak

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I saw the same exuberance in 2007 stock market. The financial crisis unfolded in 2008 and the stock market crashed 50% from its peak. How many people had lost money? Those who lost the most money were those who bought near the market top. They were enticed when everyone was making fast money. Subsequently, they dumped the stocks at low prices because they could not take the pain anymore. They follow the “buy high and sell low” mantra and they still think their investment decisions were rational.


Buying High and Selling Low in 2008

Greed (Kiasu) and Fear (Kiasee)

The culprits for buying high and selling low are the feeling of greed and fear in us. Everyday, like it or not, we make a lot of decisions based on emotions. We choose certain food for lunch because we ‘feel’ like eating that. We buy certain design and colour of clothes because we ‘feel’ it is nice. We ‘like’ to do certain things because we ‘feel’ happy doing them. We are not as rational as we think we are. Emotions make us very poor investors because greed forces us to buy when prices are high and fear forces us to sell at the low. Hence, the profitable way of buying low and selling high is very difficult to do. We all know to control our weight is to eat less and exercise more. It is easy to understand but very difficult to do. Very few people are interested in the stock market or property market when prices are low. Most people would rather go shopping, watch movies or enjoy their hobbies than to look at the markets. However, they soon generate interest when they hear stock prices have risen and people are making money. The cycle of buying high and selling low repeats.

Investing is a path dependent process – do not just look at the returns

PP drawdown

During my talks, I usually recommend to the audience the Permanent Portfolio (PP) as a solution to counter their inclination to buy high and sell low. However, some still missed the point and focused on the wrong aspects of PP. PP is decent to grow at a rate of 8% per annum. Some are not satisfied with such returns. They compare with an all-stock portfolio that can probably return 10% per year. The fatal mistake is looking at one side of the coin – the potential profit. They did not look at the potential loss. An all-stock portfolio can suffer up to 50% loss from the peak. How many people can stomach such big drop without selling out in fear? The beauty of PP is that the volatility is very low and based on Teh Hooi Ling’s 10-year backtest on PP, there is only one down year in 2008. In this period, the peak-to-trough drawdown for STI was more than 50% compared to 7% for PP. Hence, most investors would not be scared out of position with PP. For someone who chose to go for higher returns, and yet does not have the risk appetite to stomach the drawdown, would have sold the all-stock portfolio at the low. Hence, he will never achieve the 10% average annual returns.

Important points to remember

If you are not having successes in your investments, you have to reflect if you have been buying high and selling low. You will need to learn to reverse this process so that you can reverse your fortunes. Remember the following pointers when you invest:

  1. Volatility can make you very rich or very poor. Make sure you can stomach the roller coaster ride.
  2. The higher price you pay, the lesser holding power you will have when prices tank, and the higher chance you will buy high and sell low.
  3. Look at the maximum risk or drawdown over and above the returns. You will have no problem when your investment portfolio is performing. Think about how you will react if your portfolio value is halved. Will you sell? If you will, you need a portfolio with lower volatility and drawdown.
  4. Besides patience, long term investors need to overcome the fear of loss and sit tight when prices tank. Otherwise, they will never achieve the average returns in the long run.


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