The Biggest Investment Mistakes — and How to Avoid Them
Succeed Phenomenally by Not Failing Catastrophically
Getting too many emails? Control what types of emails you receive from us.
In my recent essay on inversion, I make the case for succeeding phenomenally as an investor by not failing catastrophically. I connect the philosophies of the greats — Howard Marks, Michael Mauboussin, Danny Kahneman, and Charlie Munger — while exploring the nuances and effectiveness of an inversion-first approach.
This piece builds upon my essay by bringing you examples of mistakes that set back investors on their road to success. The following insights are drawn from exclusive interviews conducted by MOI Global.
Joel Greenblatt once observed that learning from mistakes is crucial but also extremely difficult to implement. I don’t remember the exact quote, but Greenblatt said something to the effect that past mistakes dress up in new clothes and come back to haunt us. Greenblatt’s insight resonated with me, as I have made the same mistakes more than once. In each case, the specific situation was slightly different and seemed unique — but it wasn’t.
We are prone to thinking that old mistakes are safely behind us, because we tend to be on guard against them. Then, the market teaches us a lesson. Nonetheless, even as learning from past mistakes is easier said than done, there is no path toward improvement that does not include reflecting on our mistakes — and those of others.
We have asked countless fund managers about investment mistakes and have received many insightful answers. I’ll highlight a few:
Howard Marks, co-chairman of Oaktree Capital Management:
“…people tend to get in trouble in investing when they have unrealistic expectations, especially when they have the expectation that higher returns can be earned without an increase of risk. That is a very dangerous expectation.
Which is the thing that is most dangerous to omit? I think it is risk consciousness. The great accomplishment in investing is not making a lot of money, but is making a lot of money with less-than-commensurate risk. So you have to understand risk and be very conscious of it and control it and know it when you see it. The people that I think are great investors are really characterized by exceptionally low levels of loss and infrequency of bad years. That is one of the reasons why we have to think of great investing in terms of a long timespan. Short-term performance is an imposter. The investment business is full of people who got famous for being right once in a row. If you read Fooled by Randomness by [Nassim] Taleb, you understand that being right once proves nothing. You can be right once through nothing but luck.
The law of large numbers says that if you have more results, you tend to drive out random error. The sample mean tends to converge with the universe mean. In other words, the apparent reality tends to converge with the real underlying reality. The great investors are the people who have made a lot of investments over a long period of time and made a lot of money, and their results show that it wasn’t a fluke — that they did it consistently. The way you do it consistently, in my opinion, is by being mindful of risk and limiting it. […]”
Guy Spier, chief executive officer of Aquamarine Capital Management:
“The biggest mistake is when we as investors stop thinking like principals. When we think as principals, when we apply Ben Graham’s maxim that we should treat every equity security as part ownership in a business and think like business owners, we have the right perspective. Most of the answers flow from having that perspective. While thinking like that is not easy, and most of the time the answers are not to invest and to do nothing, the kind of decision-making that flows from that perspective tends to be good investment decision-making. […]”
Bryan R. Lawrence, founder of Oakcliff Capital:
“[The single biggest mistake is] not having the right temperament or sufficient balance in their lives, to manage through the humbling experience of the markets. The Great Crisis found the cracks in a lot of relationships and the demons in a lot of personalities. Buffett talks about the financial consequences of a receding tide, but we should also think about the psychological consequences. Certainly the brokers don’t have to push too hard to get the clients to change managers after a bad streak. […]”
Jean Pierre Verster, chief executive officer at Protea Capital Management:
The most expensive mistake in investing, in my opinion, is selling too soon (and, relatedly, thinking it is too late to buy), specifically in the case of long-term compounders, i.e. companies which grow their intrinsic value per share at an above-average rate over the long-term. Even the best investors have painful tales related to this mistake, whether it’s Warren Buffett recalling not buying enough Walmart shares in the early days or Mohnish Pabrai describing how he sold his Amazon.com shares in 2002 after a quick 40% return, missing out on the next 11,500% for the 16 years thereafter (34.6% p.a. to date).
Mark Massey, founder and chief investment officer of AltaRock Partners:
“Several things come to mind as I think about it… making emotional decisions… short-term thinking instead of long… a lack of thoroughness in due diligence… These are all issues, but I think the best answer to the question is a little more subtle… and it’s that most investors fail to properly weigh and adequately take into account that they are players in a pari-mutuel betting game. So you probably know what I mean by that, but let me elaborate.
Most people know how horse-betting works. Before the race begins, all the bets are tallied up, and based upon all the bets, the odds are calculated… and so what ends up happening is that the top horses — the ones with the best pedigrees, the best jockeys, and the best track records — end up paying out very little profit when they win, which is most of the time. And while the payoff can be great when the worst horses win, the fact is, they rarely do. Investing is much the same. Great businesses — the ones that have demonstrated competitive advantages and have enjoyed long records of success — are almost always priced very expensively, while poor businesses are almost always correctly cheap. Consequently, it is hard to do better than average betting on either.
The secret to winning in horses and in securities is the same. You need to study like mad and be really patient. Every now and then you will come across a really great business (or horse) that for one reason or another is mispriced, sometimes severely so, and this is when you invest (make a bet). The rest of the time you just keep working hard and waiting. You only bet when you are convinced you have a near cinch. […]”
Don Yacktman, partner and portfolio manager of Yacktman Asset Management, on how to deal with investment mistakes:
“When one makes a mistake, admit it, learn from it, move on, and try to improve on what the mistake was so that we don’t repeat it over and over again. […]”
Brian Bares, portfolio manager of Bares Capital Management:
“My experience tells me that individual investors run into the most trouble with the simple things: saving habits, proper diversification, and sticking to their investment policies. My peers in institutional investing probably run into the most trouble when they mistake familiarity with excellence. You may know everything there is to know about an idea, but that doesn’t necessarily make it a good idea. Also knowing when you have an edge is very difficult, but in my experience it is the critical factor that allows us to stand out in the ultra competitive world of institutional money management. […]”
Pat Dorsey, chief investment officer of Dorsey Asset Management, on the mistake of confusing growth for competitive advantage: