Saturday, November 2, 2013

Make the Most of Your Investing Mistakes

Like most people, I don't like being wrong. Trouble is, I'm wrong quite often.

To err is human, after all, and I've come to accept the fact that I'll make incorrect choices in the course of everyday life, such as the time I was about the head outside wearing both a corduroy jacket and corduroy trousers before my wife mercifully stopped me and corrected my obvious fashion misjudgment.  

When it comes to investing matters, however, I have yet to similarly come to terms with making incorrect choices. I tend to dwell on the mistakes I've made in my portfolio far more than I enjoy the successful moves I've made. A dent to my pride can be repaired, but a permanent loss of capital cannot.

The key to managing investment mistakes, as I've come to learn the hard way, is to admit them quickly, correct the mistake, and use the expensive lesson to improve your investment process.

  • Admit them quickly: This is the hardest part. Your research and thesis turned out to be wrong, but it's easier to be stubborn and rationalize the mistake. In my own experience, I've found that writing down my thesis before purchasing a stock has helped me own up to my mistake and not succumb to "thesis drift." 
  • Correct the mistake: Investors who've made a mistake often compound the mistake by either waiting for the market to correct it for them -- the classic, "I'll just hold on until the price gets back to my purchase price" -- or doubling-down on a broken thesis hoping the lower cost basis will fix things with time. In this situation, it's best to close your position and reallocate your capital to a better idea. (I should note here that if your thesis remains intact but the stock price has simply fallen a bit due to short-term concerns, that's not necessarily a mistake on your part and it may in fact be wise to hold or double down).
  • Improve your investment process: Do a post-mortem on your mistake. Determine where you went wrong with your research and/or thesis and apply the lessons to your process going forward. In fact, I recommend including a pre-mortem in your investment process and think about what could go wrong before you buy the stock. For instance, ask yourself, "If the stock falls by 50%, what happened?"
Investing is, by nature, a humbling endeavor and we can't always be right. In this business you're a legend if you're consistently right 6 out of 10 times, which still leaves 4 mistakes out of 10 to address. Acting as if the mistakes never happened doesn't do anyone any good. Instead, by learning to make the most of our investing mistakes -- while ultimately seeking to minimize their frequency -- I believe we can greatly improve our long-term results. 

Good reads this week

Going for Long-Term Growth - Interactive Investor
The First Law of Thermodynamics and Investing Risk - Monevator
The Intersection of High Quality and Cheap Valuation - Fidelity

Quote of the week

"Life is not always a matter of holding good cards, but sometimes playing a poor hand well." – Jack London

Thanks for reading!