Years ago, I penned an article detailing my most significant missteps in the realm of stock investments. Back in 2018, the focus was primarily on specific, individual errors tied to my investment choices, such as the pricing cartel among major potash producers during my analysis of K+S. Recently, I revisited my investment journey, aiming to conduct a thorough review of my past decisions and pinpoint the overarching issues that consistently undermine returns.
This time, my approach was more systematic, leading me to identify a list of five critical mistakes affecting performance. While some of these insights might not come as a surprise, the analysis confirmed suspicions I had long held and that many investors likely share.
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Understanding the categories of investment errors
An intriguing finding from my review was the realization that a significant portion of these detrimental factors was not tied to the initial selection of stocks. Instead, they were more about portfolio management tactics, specifically, the timing and strategy behind buying more shares or selling existing ones.
Common mistakes in stock selection
The first category of errors includes what I term follower investments. These are instances where we base our purchases on the recommendations or portfolios of other investors. The pitfall here is not necessarily the quality of the advice but the lack of personal conviction in the investment decision.
When we make follower investments, we can easily lose confidence, especially during turbulent market phases. For example, if a company reports disappointing quarterly results, the stock may drop significantly, leading us to question our initial choice. Without having conducted a thorough analysis ourselves, confusion sets in. Should we sell, buy more, or simply hold our position? Those who crafted the original investment thesis will likely have a clearer understanding of whether the poor results affect their long-term outlook and how to proceed.
Errors of omission in investing
Another notable error is known as the error of omission, a term borrowed from psychology that refers to mistakes made by failing to act. Charlie Munger, a renowned investor, has emphasized that the most regrettable errors often stem from missed opportunities rather than poor decisions made. He famously stated, “Errors of omission cost us far more than errors of commission.”
This error occurs when we recognize a promising investment but fail to act due to reasons like uncertainty or overthinking. Perhaps we understand the business model, agree with the valuation, and see favorable market conditions, yet we hesitate, waiting for a better moment that may never come. Later, we realize that we missed out on substantial gains due to our inaction.
Pitfalls arising from portfolio management
In the second category, we find mistakes related to management of existing positions. A particularly painful experience many investors face is the roundtrip. This happens when a stock initially surges in value, prompting us to hold onto it, only to see it eventually return to our original purchase price. Although we may have enjoyed a temporary gain of 50% or even 100%, in the end, we find ourselves back where we started. I experienced this firsthand with a stock like Drillisch.
Roundtrips underscore a vital lesson about investor psychology. We often mentally lock in profits too early, only to hold on when the stock declines, hoping for a reversal that may not materialize. These situations are particularly prevalent in cyclical companies, where market trends can mislead us about the stability of our investments.
The dangers of early exits
Closely related to roundtrips is the issue of early exits. This refers to the scenario where we sell a stock too soon, often out of a desire to realize immediate gains. While a profit of 50% feels good, it can lead to frustration if the stock subsequently skyrockets in value. I found myself in this position with Netflix.
Early exits frequently occur due to two main factors: fear of losing profits or a lack of confidence in the investment’s long-term potential. By selling prematurely, we not only forfeit further gains but also miss out on the compounding effect that can occur over extended holding periods. A disciplined approach, focusing on the fundamentals and maintaining a long-term perspective, can help mitigate the risk of early exits.
Addressing running losses
One of the gravest mistakes in investing is allowing losses to accumulate without taking action. We all understand the logic: a 50% decline requires a 100% gain to break even, and a 75% drop necessitates a 300% rise. The deeper the loss, the more challenging it becomes to recover. Investors often overlook the fact that the lost capital doesn’t have to come from the same underperforming stock.
Moreover, holding onto losing positions can create cognitive dissonance, where we struggle to justify our inaction. To avoid this, it’s advisable to reassess positions when losses reach around 20-30%. This evaluation should lead to one of two decisions: either increase our stake or exit entirely. A similar approach applies to the duration of our investments; if a stock takes significantly longer to appreciate than anticipated, it may be wise to consider reallocating funds.
In conclusion, identifying and addressing these common pitfalls can significantly improve portfolio performance. If investors can effectively mitigate even half of these five issues, they’re likely to see a noticeable enhancement in their investment outcomes.
