Big Mistakes: The Best Investors and Their Worst Investments (Bloomberg)

by Michael Batnick

We're risk averse, we anchor to our purchase point, and we're all manipulated by hindsight bias.

Very true

when we experience failure, usually it's self‐inflicted, which makes dealing with it objectively a very daunting task.

just when you think you've got it all figured out, the market will humble you once more. It

Warren Buffett said, “What counts for most people in investing is not how much they know, but rather how realistically they define what they don't know.”

stock prices quoted in the newspaper and the underlying value in the business are not equivalent. Sticking

The most important lesson that investors should take from the person who taught us the difference between value and price is that value investing is not a panacea. Cheap can get cheaper. Rich can get richer. Margins of safety can be miscalculated, and value can fail to materialize. Some investors search for companies that they expect will grow their earnings significantly faster than the broader market.

Graham liked stocks selling for one‐third less than their net working capital.

Graham taught his students and his readers that prices fluctuate more than value, because it is humans who set price, while businesses set value.

In the four years from 1929 to the bottom in 1932, Graham lost 70%. If such a careful and thoughtful analyst can lose 70% of his money, we should be very careful to understand that while value investing is a wonderful option over the long term, it is not immune to the short‐term vicissitudes of the market.

One of the keys to successfully managing your money is to accept, like Buffett did, that there will be times when your style is out of favor or when your portfolio hits a rough patch. It's when you start to reach for opportunities that you can do serious damage to your financial well‐being.

Overconfidence is so ingrained in our DNA that even if we're aware of it, shielding ourselves from it becomes supremely difficult.

Do you know something that's not in the newspaper or on the Internet? Will we know when we're right? What about if we're wrong? Overconfidence is so ingrained in us that just being aware of it does nothing to prevent it.

The best way to guard against overconfidence when making speculative investments is to have a plan ahead of time. Know when you're wrong; use price levels, dollar loss levels, or percentage

Making decisions ahead of time, especially decisions that involve admitting defeat, can help conquer one of the biggest hurdles investors face; looking in the mirror and seeing an ability that we just do not possess.

The world is always changing, but our views usually don't evolve alongside

Most of the gains in the stock market come from the giant winners. In fact, most stocks downright stink. Four out of every seven common stocks in the United States have underperformed

because there are so many lousy stocks, there's a high probability that over time, you will be exposed as an ordinary person, possessing no superior stock‐picking ability than the person sitting next to you.

But they got into trouble, like so many successful investors do, by straying from where their bread was buttered.

Dealing with your own emotions is challenging enough. Dealing with the emotions and pressure of others is even harder.

Cullen Roche said, “The stock market is the only market where things go on sale and all the customers run out of the store….”

Stocks tend to swing in a wide range, spending a lot of time at the fringe and little time near the average, delivering maximum frustration. This sort of erratic behavior transfers money from the amateur's pocket and into the professional's.

The idea of caring that someone is making money faster [than you] is one of the deadly sins. Envy is a really stupid sin because it's the only one you could never possibly have any fun at. There's a lot of pain and no fun. Why would you want to get on that trolley?

The more time you've spent coming to a conclusion, the harder it is to change your mind.

Let's pretend that we knew with complete certainty that Apple's earnings will grow by 8% a year for the next decade. Would this give you the confidence to buy its stock? It shouldn't, and here's why. How fast is the overall market growing and how fast are investors expecting Apple to grow? Even if we have clairvoyance on the most important driver of long‐term returns, earnings, it wouldn't be enough to ensure success. The missing ingredient, which cannot be modeled by all the PhDs in the world, is investor's moods and expectations. Investing with perfect information is difficult – investing with imperfect information and cognitive biases has made mincemeat out of millions of investors.

With investing, the odds are determined by investor's expectations, and they're not published on any website.

You can have all the information in the world, but humans set prices, and decisions are rarely made with perfect information.

Everybody likes to think they're long‐term investors, but we don't pay enough attention to the fact that life is lived in the short term.

Keynes wrote, “This long run is a misleading guide to current affairs. In the long run we are all dead.”

Long‐term returns are all that matters to investors, but our portfolios are marked to market every day, so when short‐term turbulence arrives, long‐term thinking flies out the window.

Keynes's animal spirits. He realized that he could have all the information in the world, but without the ability to control his own behavior, and predict the behavior of others, it was less than meaningless.

Successful investors construct portfolios that allow them to capture enough of the upside in a bull market without feeling as if they're getting left behind, and a portfolio that allows them to survive a bear market when everyone around them is losing their mind.

The most disciplined investors are intimately aware of how they'll behave in different market environments, so they hold a portfolio that is suited to their personality. They don't kill themselves trying to build a perfect portfolio because they know that it doesn't exist. Rather, they embrace what Keynes is incorrectly attributed to have said: “It is better to be roughly right than precisely wrong.”

it's virtually impossible to have fantastic success and keep your ego in check. We're all overconfident to begin with, and huge gains make our feet levitate off the ground.

Let's say you have a portfolio that's worth $100,000 and you know that you cannot stomach losing more than $30,000. Assuming that if stocks get cut in half and that bonds will retain their value (and that definitely is an assumption, nothing is guaranteed), do not put any more than 60% of your portfolio in stocks. If that 60% gets cut in half, you should still be okay.

lousy investments cannot be avoided. Tough times are simply a part of the deal.

The average intra‐year decline for US stocks is 14%, so a little wind in the bushes is to be expected.2

Corrections occur all the time, but rarely do they turn into something worse, so selling every time stocks fall a little and waiting for the dust to settle is a great way to buy high and sell low.

In the past 100 years, we've experienced just a handful of truly awful markets; the Great Depression, the post‐go‐go years meltdown, the 1973–1974 bear, the dot‐com bubble bursting, and most recently, the great financial crisis. Selling every time stocks fall a little is no way to invest because you'd live in a constant state of regret, and regret is one of the most destructive emotions in the cognitive‐bias tool kit.

Investors don't just exist in the present state, they carry past experiences with them. This is dangerous because it leads us to const...

Humans come preprogrammed with something called hindsight bias.

It's a defect in our software that falsely leads us to believe we knew what was going to happen all along, when in reality we had no clue. Hindsight bias leads to regret, and regret leads to poor decision making.

Regret is highly correlated with emotional extremes, and emotional extremes happen when you have either big embedded gains or losses.

The best way to minimize future regret when you have big gains or losses is to sell some. There's no right amount, but for example, if you sell 20% and the stock doubles, hey, at least you still have 80% of it. On the other hand, if the stock gets cut in half, hey, at least you sold some of it. People tend to think in all or nothing terms, but it doesn't have to be that way. Thinking in absolutes is almost guaranteed to end with regret. Minimize regret and you'll maximize the chances of you being a successful investor over the long term.