Buying the wrong shares can seriously destroy your wealth, as this Fool analyst found to his cost. He shares his 3 costly lessons learned.
As any graduate of Alcoholics Anonymous knows, the first step to setting out on the proper path is admitting your weakness. In that spirit, I'm writing about my biggest mistake so far during this bear market. Here. Publicly. For the whole world to see.
If legendary US-based investor Peter Lynch of Fidelity Magellan fame could educate investors by publicly to holding AIG (NYSE: AIG) and Fannie Mae (NYSE: AIG) at the end of last year, what's an analyst like me got to lose?
I hope two things come of my story:
- Someone, somewhere out there learns something from my mistakes. Feel free to consider me a sacrificial teacher.
- Having studied psychological commitment and consistency in Robert Cialdini's classic work Influence: The Psychology of Persuasion, I hope that my public commitment to avoid repeating these mistakes prevents me from falling victim to them again.
Mea Culpa
My greatest investing failure of the past year has been my investment in Allied Irish Banks (NYSE: AIB). To date, I'm down 88%. Not quite as big a loss as investors in Royal Bank Of Scotland (LSE: RBS) and JJB Sports (LSE: JJB) have experienced, but what consolation is a few percentage points' difference when you've lost 88%?
And yet, painful though that loss is, seeing how avoidable this was in hindsight hurts even more. Perhaps the only comforting thought is that in Warren Buffett's recent Berkshire Hathaway annual report, he writes that he also suffered a significant loss by investing in Irish banks. Some have speculated that AIB was among them. So at least I was fooled alongside a much better investor than me.
Following The Crowd
My first major mistake was falling prey to social proof. I put too much weight on the research, opinions and actions of others, without thinking through my investment decision for myself, and deciding whether it made sense in my portfolio.
Prior to my purchase of AIB, it had been recommended by one of The Motley Fool's US-based newsletters, and purchased by the team charging up our real-money US-based Million Dollar Portfolio real-money service. Advisors in both services wrote that the stock was trading with low historical and relative multiples, a very attractive dividend yield, and a significantly undervalued price.
While they made compelling arguments, I failed to carefully evaluate whether I agreed with their assessments. And I became even more hooked as these fellow analysts also began purchasing AIB for their personal portfolios.
As a result, I also began to give in to confirmation bias -- where I sought out opinions that further confirmed my buy decision, rather than seeking a contrarian opinion that might indicate danger ahead.
Seth Jayson, co-advisor of another of our US-based newsletter services, recently shared with me that confirmation bias is one of the most common predispositions investors face. He explained that truly great investors develop an ability to honestly look at both sides of an investment thesis.
Anchoring In Loose Sand
As if those mistakes weren't enough, I also became anchored to the price at which each service recommended the stock. I fixated on those price points; in my mind, anything lower than their entry prices became a clear bargain.
So when AIB fell another 50% from the most recently recommended price, the shares became twice as attractive to me, as did the doubled dividend yield.
These mistakes fed off each other, collectively convincing me to overlook my normal investment process. I took shortcuts. I failed to perform as much research as I typically do. I fell in love with the shares, viewing it as mostly upside, without truly understanding the risks and pressure points. And I didn't even consider the possibility of a suspended dividend (which recently beset the company).
This company -- which, hurt by the falling Irish economy, recently needed to boost its construction and development loan reserves -- was much more complicated than I originally thought. The complexity of AIB forced me to look to other investors, and to bypass my investment process.
Lessons Learned
The key takeaways from my mistakes, then, are:
1) While it can be helpful to look at the opinions of others, you still need to carefully consider whether you agree with their investment theses. Even if AIB had risen 88%, it still would have been a mistake for me to buy it, because I hadn't sufficiently examined the reasons for owning it. You must be able to distance yourself from the positions of people you respect.
2) It's much better to leave a share's price history out of your analysis, so that you're not tricked into a value trap. Companies can, and often do, change. Lloyds Banking Group (LSE: LLOY) might have looked cheap in the middle of 2008, when it was down nearly 50% from just nine months earlier. But after buying basket-case HBOS (RIP), coupled with the sharply slowing economy, the shares have fallen another 60% since then.
3) It's best to simply bypass investments that are too complex, or that you don't believe you solidly understand.
These takeaways are heavily studied by The Motley Fool UK's own Chief Investment Analyst Maynard Paton. Maynard is constantly on the hunt for the highest quality small to medium sized businesses to recommend to Members of his Champion Shares premium stock picking service. He is offering you the chance to read all his research so you can see if you agree with his analysis. Click here for a free guest pass -- there's no obligation to subscribe.
More on the economy and the markets:
> The Motley Fool's Share Dealing Service is growing quickly too. Buy and sell shares in real time for a flat rate of just £10. It's hard to beat. Open an account for free today. There is no obligation to trade.
> This article was first published on Fool.com. It has been updated.
> At the time this article was first published on Fool.com, analyst Adam J Wiederman owed shares of both Allied Irish Banks and Berkshire Hathaway. Of the companies mentioned in this article, Bruce Jackson also owns Berkshire Hathaway plus Lloyds Banking Group.
