Some things are so obvious, Stevie Wonder could see

Nobody likes to stuff up. Making errors is, generally, a pretty annoying part of life.

Of course, the bigger the cockup, the bigger the required clean up.

I’m really no fan at all of the avoidable clean up. You know, making things right from a disaster that even Stevie Wonder could see coming a mile away.

It’s the main argument, in my opinion, against having children. They’re constantly buggering things up in ways that were eminently foreseeable – as in before you handed them the tubes of paint, left scissors lying around or didn’t put the ladder away. In the early years, kids and new stuff have win-loss ratios like the GWS Giants.

For obvious reasons, I find financial stuff-ups the most annoying. I hate seeing cash blow up. Mine especially.

So, I do what I can to avoid scoring parking tickets, buying clothes that I’ll never wear, spending big bucks on cars, paying bank fees or interest on my credit card, travelling in peak hour, playing the pokies and wasting food.

And when it comes to investing, I avoid buying individual small cap stocks – the stocks that make up the bottom half of the ASX200, ASX300 or All Ordinaries.

I don’t have the time to do ’em properly.

People can and do make above average returns from small cap investments. The small companies can double, triple or do a ten-bagger in amazingly short periods of time.

It’s not that they’re bad investments. They’re just inherently riskier investments. The chance one you’re holding could inexplicably enter liquidation is real. Many of them do, every year. And they take everything with them.

Mining services minnow Forge Group has done exactly this in recent weeks. It collapsed with debts of $500 million. About 1500 jobs quickly went.

The “corporate recovery” buzzards started circling. You never want to hear names like “Ferrier Hodgson”, or “KordaMentha” used about companies you’re invested in.

I didn’t own shares in them. But a friend did.

I wouldn’t call him a “day trader”, but he was certainly playing in the tiddlers and for rather short periods. He’d had a couple of previous wins, including Forge.

The amount he lost is going to hurt. It’s “just a flesh wound”, though not as serious as the armless and legless Black Knight from “Monty Python and the Holy Grail”.

Why are small cap stocks different to blue chips?

Because more people can move the stock, with less effort. You’re betting with/against fewer people. An investor with $100,000 isn’t going to move BHP Billiton, Telstra or Commonwealth Bank. But they can really ramp up, or play havoc, with a small cap.

Small caps usually don’t have the same systems and processes in place as large companies. Large companies got to where they were by being very successful at doing the same thing over and over again, usually millions of times.

Penny dreadfuls don’t have the diversification associated with blue chips. They might only operate on a few sites in Australia, where BHP operates mines around the world. Small caps have small share registers, where large caps often have hundreds of thousands of investors.

The information flow with small caps is less. Fewer people know much more. Most people know nothing. And by the time word filters out, it’s largely too late.

In short, small caps carry far higher risk than blue chips. If you’re going to “play” in them, you need to be on top of them and read every release and every story about them. That’s not the case with blue chips.

But we were talking about errors, mistakes and cockups. What does that have to do with small caps?

Avoidable mistakes in small caps occur when you end up holding the hot potato that everyone else has dropped, because they knew information you didn’t.

Mistakes occur when you bet too much on one stock.

The implosion of a number of small cap stocks each year is not just eminently foreseeable, but undeniably probable.

Understand that if you’re playing in small caps, you either need to be both on top of the information and an awesome reader of charts.

Or you need to have enough money invested elsewhere that watching one or two tiddlers vapourised won’t cause a clean up bill for your finances that you can’t afford.

Bruce Brammall is the author of Debt Man Walking (www.debtman.com.au), a licensed financial adviser and mortgage broker. bruce@debtman.com.au.