Experienced investors have seen a lot in their days, and those who were around during the Dotcom era saw the unpredictable highs of the last great equity bubble. A mere mention of the internet would be enough to send a stock skyrocketing, and we saw parallels of this in the Bitcoin bubble back in 2017.
However, as we grow older and wiser, we think we know it all. Yet very often it’s the same three mistakes that keep tripping us up. Being aware of these mistakes can save us from hefty losses and protect our portfolios.
Concentration has to be earned. Yes, Warren Buffett says that we should “put all of your eggs into one basket, and then guard that basket with your life”, but that advice works for him because he’s earned it. We may not have. Concentration builds wealth, but it’s also the quickest way to destroy it. Design your portfolio carefully so that you are not at any substantial risk in a single stock.
We can achieve concentration while still remaining relatively diverse by owning less than 20 stocks. It’s unlikely that we would ever equally weight them, as more capital should go to our best ideas – that is what drives alpha – but if we had all of our stocks equally weighted and one was to go bust, then we would only lose 5% of our total portfolio. That’s not great, but it’s not exactly disastrous either.
Another thing that causes investor downfalls is the act of averaging down. This can be a successful strategy on the right stock, but any investor who averaged down during the Dotcom bubbles, or with stocks like Kodak, Carillion, or Debenhams, eventually lost all of their money.
When making the decision to average down, proceed with caution. When investors are buying stock, they believe the stock offers value. When the stock goes lower, it offers more value, in theory. However, if the investor turns out to be wrong about the stock’s value, then they are throwing good money after bad.
One big problem of experienced investors is that because they’ve been around the block they think they can tell when management are lying to them. Unfortunately, a good liar can hoodwink even the most experienced of investor. But the good news is the financial statements will often verify what management say. If that is not the case – then you need to ask yourself, why not?
Remember, management’s job is to sell shares. They will only ever tell us the good stuff. They won’t be telling us what’s going wrong at the company, and they won’t give the real reason why the CFO left last month.
It’s our job as investors to work out the worst case scenario, and use this information to test management when meeting or speaking with them. To not do so is a serious disservice for your investments.
Views expressed in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.