Investing in the sharemarket is fairly straightforward, but not as easy as it seems.
Firstly, by investing directly in shares, the investor's implicit goal is to beat the market – unless you like losing money. If you can't beat the market, it's quite ok to say, "I'll invest conservatively and take the market return by investing in exchange-traded funds (ETFs) or Listed Investment Companies (LICs)". You're likely to do much better than most other investors over the long term.
It also pays to remember that when you are buying shares, someone on the other side is selling – and they likely have just as good a reason to be selling as you do to be buying. One of you is probably going to be wrong.
Many investors, particularly retail investors, clearly don't understand or consider the risks they are taking on. Sure, leaving your money is a bank account earning 2% or 3% a year is hardly appealing when you have literally hundreds of companies on the ASX paying dividend yields of 5% or more.
However, danger lurks for those unaware.
As we've seen with Dick Smith Holdings Ltd (ASX: DSH) and its recent profit downgrade, and subsequent slide in the share price, investors in the IPO were dudded – something we suggested when the company first listed.
In recent days, some excellent analysis from fund manager Forager Funds outlined how investors were hoodwinked, while the seller walked away with hundreds of millions of dollars in profit.
We've also warned multiple times about the risks of investing in Chinese stocks listing on the ASX. The lack of transparency, some questionable accounting, a history of fraudulent activities on other stock exchanges and even some on the ASX that appear downright fraudulent, should have most investors avoiding the sector – despite the apparent attractiveness on paper.
And yet, we still have small (and big) investors ignoring the potential risks, investing in companies they don't know in depth, and ending up losing large sums of money.
I'm still astounded when I hear investors calling up Sky Business to ask about a two-bit penny explorer they own shares in and clearly know nothing about. (Should they still be called investors or perhaps speculators?)
For most investors, there's an enormous difference in the risk associated with investing in say a large, well-known company such as Woolworths Limited (ASX: WOW) and perhaps a tiny resource or energy explorer, biotech stock or Chinese-listed ASX company, despite the former's well-publicised current issues.
Foolish takeaway
When it comes down to it, investing in the sharemarket involves taking some risk. Attempting to beat the market means playing the odds and limiting your downside risk.
Ignoring the risks and focusing purely on the upside means you deserve to get burnt.
