This trend has become so worrisome that the researchers determined that new investors would have better luck choosing stocks at random rather than just sticking to what’s comfortable and predictable.
“If you don’t diversify, when one asset does well the other ones are also going to do well,” said researcher David Hardisty. “But if one does badly it’s likely the others will all do badly -- and in investing, you want to avoid those worst-case scenarios.”
Getting the most out of investments
To understand how new investors were going about their investment options, the researchers had a group of inexperienced investors create a mock portfolio of stocks they’d be most likely to choose on their own. In doing this exercise, the researchers were able to analyze the participants’ stock choices and also gauge their financial literacy.
Ultimately, the researchers determined that new investors picked stocks that seemed the least complicated, which can actually have an adverse effect that leads to more money lost.
“An amateur investor might buy stocks in lumber, mining, oil, and banks, and believe they are diversifying because they’re investing in different companies and sectors,” said Hardisty. “But because all of those equities tend to move in unison, it can be quite risky, because all the assets can potentially plunge at the same time.”
The researchers want consumers to know the importance of diversifying investments, as doing so allows some wiggle room as stocks rise and fall. They encourage consumers to look for investments that have different trending patterns to ensure that money is coming in at all times.
“In the best-case scenario you could make lots of money and have an extra vacation or buy a car or something like that,” said Hardisty. “But if your whole portfolio crashes you could risk losing your life savings. So, the best-case scenario isn’t that much better, but the worst-case scenario is a whole lot worse.”
Gaining financial literacy
Feeling comfortable and knowledgeable about finances can help consumers make smarter financial decisions in the long run. Previously, experts at the United States Treasury emphasized the importance of college students taking courses in financial literacy.
Mandating that students take courses in financial literacy can lead to better overall financial decisions, including higher credit scores and fewer issues paying bills or loans back.
“Courses taught by institutions of higher education can improve students’ financial knowledge, build key financial literacy skills, and promote sound financial actions during and after their education,” wrote the U.S. Department of the Treasury and the Financial Literacy and Education Commission (FLEC).