Web-based stock brokerage accounts make it easy for anyone to buy and sell stocks, mutual funds and other types of investments. Online investing can be a convenient option for experienced investors, but it also presents certain disadvantages that may be especially harmful to new investors and undisciplined investors. Understanding the drawbacks of online investing can help you avoid common investment pitfalls.
Research and Advice
When you open an online stock brokerage account, you are responsible for managing your own stock portfolio. Online brokerages may provide you with investment research tools, but it is up to you to research and choose investments, which can be a time-consuming process. Investors that use traditional stock brokerages can typically get investment advice from live financial professionals. Professional advice and research can clear up sources of confusion and help investors avoid making novice mistakes.
The interface of an online stock trading website can make it seem like you have a direct connection to stock markets, but online trades do not execute instantaneously. When you place a trade on a stock trading website, the actual transaction price might be different than the stock price the moment you click to make the transaction due to delays in the transaction process. Technological problems can also cause transactions to fail or create duplicate transactions.
Online investing can be dangerous for undisciplined investors, because it makes it easy to act on emotion and make spontaneous investment decisions. True stock investing requires holding stocks for long periods of time to take advantage of the gradual upward trend of the stock market. When an investor trades stocks frequently in reaction to current events and economic conditions, he may miss out on gains from long-term economic trends. In addition, online trading makes it easy to treat the stock investing as a game, where you attempt to profit from short-term stock price fluctuations. According to the Securities and Exchange Commission, this practice is called "day trading" and most novice day traders suffer large financial losses when they first try day trading and many never reach profit-making status.
The ease of trading stocks online can result in owing high taxes on investments. When you sell a stock at a price that is higher than the price you paid, you make a profit called a capital gain. You have to pay taxes on capital gains at a maximum rate of 15 percent for investments you hold longer than a year, but you pay your normal income tax rate on gains associated with investments you hold a year or less. Your normal income tax rate could be as high as 35 percent, so holding stocks long-term is preferable to frequent trading from a tax standpoint.