FOMO is what drags the last unwilling investor into the market, expert says

Many people don’t read the prospectus when confronted with a stock offering; they don’t understand the jargon, and tend to read the headlines, not the fine print (Getty Images/d3sign)

One of the biggest traps novice investors fall into is seeing their friends and associates making money in the markets and deciding to jump in too, cashing in the GICs they’ve always invested in as well as borrowing money to do so. 

That, says Larry Short, portfolio manager, senior investment adviser and executive director, Private Client Group, HollisWealth, in St. John’s, NL., is usually a sign to investment advisers that the market has topped.

Short, the author of a book on an alternative mindset to investing titled In Short: Successful Investing During Turbulent Times, remembers several occasions when novice investors lost their shirts because of that fear of missing out (FOMO) syndrome. Those losses triggered lawsuits against the financial advisers who led them astray. Sadly, he says, in most cases investors did not get their money back. 

“[Many investors] are too embarrassed to talk about this,” says Short. “And the only method of recovery in our business is to launch a lawsuit.” But, he adds, many people can’t afford to carry a lawsuit for an extended period of time. “So, in many cases, the investors walk away with the losses and are forever scarred, to never invest again,” he says.

A TOUCHY SITUATION

Because of that embarrassment, we don’t hear about the prevalence of losses due to poor investment choices from FOMO.

“Unfortunately, it happens an awful lot,” Short says. “The whole fear of missing out is what drags the last unwilling investor into the market.” Most recently, he’s seeing the syndrome with marijuana stocks, where many individuals who invested in a marijuana exchange traded fund (ETF) in 2018 found that this year the price of the fund was down 50 per cent because they bought at the crest of the wave, not the trough.

It doesn’t help that people don’t read the prospectus when confronted with a stock offering; they don’t understand the jargon, and tend to read the headlines, not the fine print. “It’s an incredible frustration to talk with people; as you can imagine, we get a lot of calls looking for a second opinion,” he says. 

When he gets those calls, Short asks if they received a prospectus, did they sign it, did they read it? And the answers are usually yes, yes, and no, because they couldn’t figure out what it meant, but they invested anyway because a buddy said it would work out.

“So, that’s part and parcel of it, and harkens back to the whole reason for the need for financial literacy in Canada,” he notes. “Many years ago, our pensions were taken care of by large corporations or the government in the form of a defined pension plan. Nowadays, we’ve told Canadians you have to take care of your own pension plan, but we haven’t given them the tools to be able to make proper decisions. So you know, it gets right back to the whole financial literacy issue.”

IDENTIFYING RED FLAGS

There are, however, signs that an investment opportunity may actually be a trap, Short says. One is the source of the information—that buddy is not a good choice. But also, he says, watch for the financial planning trap. Ensure the person advising you is a certified financial planner, not a just salesperson.

“Ask what the motivation is for this individual telling you that you should be investing in this particular matter,” he advises. “If it is, indeed, that they will earn a higher commission by doing this, or the company will earn revenue by doing it and you are kind of the third party, that would cause you to raise suspicion. The difficulty in our industry is trying to sort out who is a salesperson.”

He recommends clients interview prospective advisers, citing the FP Canada (formerly the Financial Planning Standards Council of Canada) list of 10 questions to ask candidates, and especially endorses the final question: Can I have that in writing?

“It’s very rare that they lie in writing,” he says. “The reason why they’re hesitant to do that is because they usually have to get a supervisor to sign off on a document typed up on company letterhead that says: ‘Here is the answer to your question. Here’s all the fees that are going to be paid. Here’s how I get paid. Here’s the risk involved with this.’ 

“That actually does make the company binding so that if it does have to go to court, it increases the likelihood that if somebody loses money on one of these ventures they can recover, because often the individuals will say something that is not covered in their prospectus. The big guard is, ask those 10 questions.” 

GET IN THE GAME

Listen to Larry Short talk about avoiding investment traps in CPA Canada’s podcast series, Mastering Money: The educator’s edition. Other episodes include the shame around debt, planning for retirement and the behavioural economics of money.