Seven of the Biggest Mistakes You Can Make in the Market and Famous Investors Who Made Them
Whether you’ve been investing for months or for decades, chances are we all have one thing in common: we’ve made mistakes, probably many of them. The most successful investors in the world all agree that, despite the simple universal goal of buying low and selling high, investing is hard. Even the all-time greats have made critical misjudgments in particular companies and entire sectors. In many cases, those losses helped forge them into the successful people they became. The key, according to most, is to take your lumps and learn from them, which is easier said than done for the normal investor. If Albert Einstein really was onto something when he described insanity as “doing the same thing over and over and expecting different results”, then many of us have to admit being a little crazy in how we approach our investments. Let’s take a look at some investing miscues through the lens of some of history’s greatest modern investors
- FOMO is not your friend.
Fear of missing out (FOMO) isn’t just a stock market phenomenon. It affects many aspects of our life, and is exacerbated by marketing companies that convince us to buy whatever it is that we didn’t know we absolutely had to have. In the stock market, any behaviour driven by an emotional response is dangerous, and FOMO may be the most dangerous of all, often pushing both rookie and experienced investors to make irrational decisions. If you’ve ever chased a stock or sector that was rapidly rising simply because you felt you were missing out, you’ve got something in common with Stanley Drunkenmiller, a very successful American investor and former hedge fund manager.
Drunkenmiller was hired by billionaire investor George Soros in 1988. The pair brought massive success to Soros’ Quantum Fund, including a bold shorting of the British pound sterling in 1992. The event, still referred to as “Black Wednesday”, pocketed roughly $1 billion USD for Quantum. But by 1999, Drunkenmiller was in a tougher spot. He had resisted getting into the tech boom earlier that decade and as a result, Quantum was being outperformed by most of its rival funds. Motivated by a need to move quickly, he bypassed his usual research process and made the emotional decision to jump on the tech train, which seemed like a locomotive at the time. Six weeks later, the train was derailed and the tech bubble burst. Drunkenmiller had bought at the top, and his losses after just a couple months totalled $3 billion, causing him to leave the firm.
Before we move on, don’t feel too bad for Drunkenmiller. He refocused his energies on the very successful Duquesne Capital Fund, which he ran successfully for another ten years. He was also credited with being the most charitable man in America in 2009, donating over $700 million to various charities and initiatives. There is quite a lot to be learned from Stanley.
Remember that FOMO can run the other way too, as the same investors who jump into a stock without researching it are often the ones who run at the first sign of trouble. Benjamin Graham, a legendary 20th century economist/investor once said “The intelligent investor is a realist who sells to optimists and buys from pessimists.” Translation: Buy low, sell high.
- Don’t just research a company; research the whole industry
The best investors look ahead to where the market is going instead of focusing on where it currently sits. Carl Icahn is one of the best investors in the United States, with an estimated worth of more than $15 billion USD. He hasn’t accomplished that success without being extremely forward thinking. His 10% purchase of Netflix in 2012 eventually netted him over $800 million, a very big win for his Icahn Capital Investment Firm. What is interesting is that he sandwiched that victory between two ultimately poor decisions, both from a lack of understanding of the future direction of the sector.
Back in 2004, Icahn had poured nearly $200M into Blockbuster Video, the former 200 lb gorilla of the video rental industry. Icahn, like most people, recognized the challenge from a fledgling company called Netflix. At that point, Netflix and rival company Redbox were subscription services with no physical locations. Icahn believed that Blockbuster’s physical stores were actually a tremendous asset, and he completely misjudged the speed and scope of online streaming. He ended up losing 98% of his investment, selling shortly before the company went bankrupt in 2010.
While Mr. Icahn did eventually catch up to the prevailing trend and buy a good chunk of Netflix after shares had temporarily bottomed out, he again misjudged the future of the sector by selling all his shares one year later. While he profited from the sale, we all know how Netflix has performed since then.
When you are considering investing in a particular company, from a large cap all the way down to a microcap, do some due diligence on the overall sector. What are the headwinds and tailwinds coming up? Will the sector still be growing in ten years?
- Don’t put all (or even most) your money into one investment.
This one seems pretty simple, but it can be difficult to resist “loading the boat” and averaging up when your favourite holding is on the rise. Similarly, when you feel a stock is undervalued, there is a temptation to overweight your portfolio with more and more “value” purchases (see #7). Most famous investors avoid this trap by diversifying their holdings, protecting them from any single massive hit to their portfolio, but sometimes even they get overconfident and slip up.
Ever seen “The Big Short”? The film is based on a book by Michael Lewis, the author of “Moneyball” and “Liar’s Poker”. The film focuses on the cheap credit and lax lending standards that lead to an American housing bubble. The bubble of course burst, leading to the most serious financial crisis in decades. Without getting too far into it, a group of people on Wall Street saw it all coming and began shorting the housing market in 2005. When it collapsed a few years later, they profited from what some call the biggest trade ever. Hedge fund manager John Paulson was one of those people, generating over $4 billion USD in profits.
Prophetic as he turned out to be, Paulson failed to diversify his windfall effectively, betting far too heavily on gold from 2010 onward. By 2013, he had lost $1.5 billion, including a week where gold dropped so dramatically that Paulson suffered a $1 billion paper loss. The moral of this story is that no single investment is worth 100% of your investment, even the very best ones. Have positions in different industries, and keep a cash position as well; you never know when you’ll need it.
*Interestingly, Paulsen isn’t represented in “The Big Short”, as he was portrayed in a different book, “The Greatest Trade Ever” by Gregory Zuckerman.
- Don’t invest in anything you don’t understand. Stick with what you know.
This isn’t to say that you shouldn’t be learning as you go. Financial education is woefully under-appreciated in our school systems, so we all have some catching up to do as adults. But knowing your own areas of strength and weakness, as well as your investing tendencies, can save you from making costly mistakes in the market.
John Bogle was a legendary investor who lived to the ripe old age of 90, passing away in 2019. He is widely known as “The Father of The Index Fund”. In 1974, he founded The Vanguard Group, which even today manages the majority of the top 20 American index funds. Vanguard quickly became the embodiment of consistent, long-term index-fund investing, with Bogle as its champion. Bogle is an excellent example of how prior mistakes, when properly channeled, can lead to future success. Before Vanguard, Bogle had climbed nearly to the top of The Wellington Fund. By the mid-60’s the market had hit the go-go era, filled with young and inexperienced professionals who promoted more aggressive trading strategies to their clients. Instead of sticking with his tried and true conservative strategies, Bogle decided to merge his fund with one of the go-go management firms. The market soon crashed and Bogle was shown the door after losing approximately $1 billion in assets for the firm.
In the end, Bogle returned to what worked for him and what fit his investment philosophy. That decision changed investing for the better. While you should always strive to learn new things, a good rule of thumb is that you shouldn’t be investing in a company or an industry unless you can comfortably explain it to someone else. Know the company; know the industry; know yourself.
- “Don’t confuse brains with a bull market” – Humphrey B. Neill
If you’ve been investing for long enough, chances are you’ve participated in a bull market. Bull markets are characterized by a rising tide of positive sentiment that causes the prices of most stocks to rise. The obvious issue that arises with investors in a bull market is overconfidence. Who doesn’t like being the resident stock market expert in his or her cul de sac? After hitting a few winning investments in a row, it’s natural to feel good about oneself, but it is absolutely vital to analyze successes just as much as failures. For example, if you had invested in almost any Canadian cannabis company in early 2017, you’d look like a genius a year later. By 2019, the sector was in full and rapid decline, and the majority of the junior cannabis companies would never recover.
Billionaire investor Ray Dalio recently discussed mistakes from his early investing years. Dalio founded Bridgewater Associates in 1975. Under his watch, it has become the world’s largest hedge fund. He has made his mistakes along the way though, and he cites overconfidence for a near career-ending mistake in the early 1980’s. In 1982, Dalio was certain that the Latin American debt crisis would lead to a more widespread depression, and he invested accordingly, ignoring research of the time and warnings that the Federal Reserve would intervene. The Fed did step in, and the crisis was largely averted. By not putting the time in to adequately assess the situation, Dalio nearly lost his firm. He was forced to lay off nearly his entire staff and basically started over after wiping out seven years of success.
Bull markets can be incredibly profitable times for investors, but for those not careful, they can lead to bubbles, such as the 2000 dot.com bubble, the cryptocurrency bubble of 2018 or the first bubble of them all: Tulip Mania, a 17th century Dutch craze in which single tulip bulbs briefly cost ten times the yearly salary of a skilled artisan before returning to the regular value of an ordinary flower. The best way to stay ahead of bulls, bears and bubbles is to know the reason why you invested in a particular company and periodically reassess whether you still believe your original thesis.
- Don’t invest what you can’t afford.
Bull markets, and the overconfidence they breed, tend to persuade us to invest money that we can’t really afford to spend, or worse yet, money we borrow from our credit lines. While there is no fast rule as to how much you should be investing, the best thing you can do is to create a budget that tracks not only your investment goals, but everything about your finances, from spending habits to salary increases to vacation expectations. Once you have comfortably budgeted for everything else you need to maintain your quality of life, you can make a decision on your investment limits. And be prepared to leave those investments for years, as markets grow over time but not necessarily over short periods of time. If you’re going to need your investment money back in two months, you shouldn’t have made it in the first place.
For this example, we have the most famous person on the list thus far, but for different reasons than the rest. Mark Twain is considered among the greatest authors in North American history. His characters such as Tom Sawyer and Huckleberry Finn remain a part of the literary fabric of American history. As brilliant as he was a writer, Twain was a dreadfully poor investor. Despite being very highly compensated for his work and marrying into an already wealthy family, Twain was prone to throwing most of his money into ill-conceived investments like a magnetic telegraph and a near-useless steam pulley. Twain was quoted as saying “I must speculate in something, such being my nature.” Only after losing and regaining his fortune several times did he amend his statement to the following:
“There are two times in a man’s life when he should not speculate: when he can’t afford it and when he can.”
Although Twain would eventually sort out his financial problems and retire in comfort, we can all learn the simple fact that earning money is far more difficult than losing it, so be smart with yours.
- Don’t throw good money after bad money.
For our final cautionary tale we go to the living legend himself, the Oracle of Omaha, Warren Buffett. Buffett’s quotes alone are a wealth of information and wisdom, and the lessons we can learn from him are nearly limitless, but even the Oracle himself has made some egregious errors, which he freely admits and often discusses. One of those errors was, interestingly, trying to support the original business model of his own company, Berkshire Hathaway. Buffett purchased the Massachusetts company in 1964, which at the time was nothing more than a struggling textile mill. Buffett recounts his “monumentally stupid decision” of pouring investment into the mill, not accepting that it was “mired in a terrible business” within an industry that was declining. He finally threw in the towel and closed the mill in 1985. We all know what he ended up doing with Berkshire and where that success has taken him, but the lesson remains for investors: don’t put more money into something just because it is down. Averaging down is a fine strategy if you feel the company is undervalued based on its business, but averaging down just to reduce your entry point is asking for trouble. If there is a good reason for the stock price to be down, then you may end up “catching a falling knife”.
Learn As You Go
Like most things in life, investing strategies develop from experience, which most often comes from failure. Never be too hard on yourself for the inevitable mistakes you will make in the markets, but also try not to make them twice. Markets change and so do investment strategies, so give your investments the attention they deserve.
References
https://www.businessinsider.com/carl-icahns-blockbuster-mistake-2016-5
https://time.com/4297572/mark-twain-bad-business/
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