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High-tech fallout: Solo investing a more dangerous minefield

By Kevin Voigt
For CNN

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HONG KONG, China (CNN) -- These are the best of times for investors who want to steer their own stock trades online.

After a long Bear Market -- punctuated by the 2000 technology stock crash, the 9/11 terrorist attacks and an onslaught of corporate scandals -- the Bull is back, its 3-year amble up Wall Street pushing the Dow Jones Industrial Average to record levels.

Online discount brokerages are proliferating, sparking a price war to lure new investors with cheap fees. And the amount of free financial information online is snowballing toward avalanche; even the New York Stock Exchange is making moves to have real-time trading information available to any Internet user.

Unfortunately, this will spell the worst of times for many pajama-clad investors who mine for gold by the glow of their home computers, according to investment experts.

The technology revolution has created a great deal of new wealth, and broadband connectivity has given individual investors light-speed efficiency. This online revolution, however, does not nurture the one thing financial experts agree is key for long-term prosperity: Patience.

"People have a hard time investing in the long-term," says Philippa Huckle, managing director of the Philippa Huckle Group in Hong Kong. "But the longer you invest, the more likely you're going to do well."

Huckle, whose investment firm handles individuals with an average portfolio of $1 million, is an acolyte with the growing number of professional investors who practice behavioral finance -- a discipline that merges economics and psychology to study how investors make decisions.

Alas, the result of this research, led by Nobel Prize winner Daniel Kahneman, suggests that investors who trust their "gut feeling" with stock trades will often be betrayed.

Blame it on Darwin: inborn "fight-or-flight" instincts that served humans well to survive prehistoric times are a liability when making investment decisions. Humans suffer from "loss aversion," research shows.

"The psychological pain of loss affects us twice as much emotionally than a similar gain," Huckle says. "In other words, losing $100,000 on the stock market hurts twice as much as gaining $100,000." This causes knee-jerk reactions of investors to sell when stocks take a downturn, rather than hold.

" People doing this (investing) on lunch breaks and at home at night are competing with huge institutions who have Harvard graduates researching investments full-time." - Philippa Huckle

Our patience for investment is slipping as more trading moves online: According to research by Dalbar Inc., from 1984 to 2000 the average stock buy was held for two years and seven months; by 2004, the average slid to two years and two months.

A buy and sell of a stock on a single day is a virtual coin toss: investors have a 50.2 percent chance of making money, according to Huckle. The longer investors hold, however, the chances of profit expand exponentially: there is a 70 percent likelihood of earning a profit holding for 18 months. Hold for five years, odds increase to a 95 percent probability of positive return, she says.

According to Dalbar, a $10,000 mutual fund investment in 1985 left to sit without withdrawal would be worth $95,000 today. That, despite losses suffered during the 1987 market crash, the 1997-98 Asian currency crisis and the technology implosion of 2000.

The hands-on appeal of online investing is akin to the comfort frightened air travelers feel sitting behind the wheel of a car. Statistics may show air travel is safer than driving, but there is comfort in control.

Yet despite the technological advances that have allowed people to trade in real time from home, the heyday of the individual investor died decades ago.

"If you go back to 1960, the majority of trading was done by individual investors," Huckle says. "Now about 90 percent of trading is done primarily institutional investors, like mutual and pension funds ... there are about 7,000 listed companies on the New York Stock Exchange, but 8,000 mutual funds."

Changing business models

Why this explosion in institutional investing? Thanks are due, in large part, to technology. When Paul Clitheroe started Sydney-based IPAC Securities 25 years ago with four other financial consultants, "we never imagined managing even as much as ($8 million) in assets." Today, the firm controls $11 billion in investments across 11,000 security products worldwide.

"Using the business model we had back then, we would need at least 450-to-500 people to research and handle that," says Clitheroe, who also serves as chairman of the Consumer and Financial Literacy Taskforce, an Australian government program to improve financial education. "Now we have 15 people dedicated to research ... that's all thanks to technological advances."

If he started again today equipped, with modern advances in online trading and information, would he go it alone? "Never, no way," he says. "I just couldn't do it."

And Huckle adds that individual investors are outmatched by corporate investors. "People doing this on lunch breaks and at home at night are competing with huge institutions who have Harvard graduates researching investments full-time," she says.

Professional investors are less likely to succumb to bad investment behavior like "home bias," the tendency of individuals to invest at least 80 percent of their portfolio in their own country. "There is a false sense of security investing with a company you know ... you invest in a company because you feel you know it, you use their products every day," she says.

But these investors rarely go beyond skin-deep research, she says. "Have they analyzed the company's marketing strategy? Are they taking into account what their (human relations) departments are doing? Have they compared the current price compared to past quarter earnings and anticipated earnings?

"Most (individual investors) don't have the resources to look at these things, probably don't have the training, and certainly don't have the time," she says.

Clitheroe likens interest in online trading to the Gold Rush in 19th Century America -- the real "gold" wasn't made by the Western flood of quick-rich dreamers, but by the entrepreneurs who sold the tents and shovels. He takes a similar view to the growing number of companies catering to online investment.

"They give (clients) a day of training to learn how to trade, and sell them a software program for trading strategies," he says. What do these opportunists do with cash earned from eager online neophytes? "They pay off their mortgage, they buy commercial property, and they make long-term investments," Clitheroe says.

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