This post has been authored by Jae Jun of Old School Value
I’m not perfect.
No matter how good you are as an investor, you are bound to make mistakes.
Even the pros make plenty of big mistakes.
Newton was brilliant but he made a dumb move during the South Sea Bubble and lost his shirt. Bill Ackman’s pride got in the way of his JC Penney investment and he ended up losing millions.
John Paulson became famous by pulling off a legendary trade against subprime mortgaged backed securities, but has made bad calls ever since.
Whatever you are investing in, there are lots of different ways to make money.
In the stock market alone, there are tons of strategies ranging from trading to options, shorting, arbitrage, leveraging and so on.
The strategies to make money is extremely diverse and it’s why most gurus don’t even agree with each other. One says to diversify, another says to concentrate. One says to buy only what you know, another says to use index funds only. But when it comes to protecting losses and avoid blow ups, there are common themes that all pros agree with.
So here they are. The Six Deadly Sins to Avoid:
Sin #1: Not Having an Exit Plan
A common root to this sin is from following somebody’s advice in buying a stock without fully understanding the situation.
It’s so easy to do with all the media, blogs and websites that promote stock picking methods that will surely beat the market.
One of the biggest problems with this sin which I’ve experienced is that if the person I relied on to get the initial information suddenly disappears or doesn’t respond, I’m left in the dark about what to do.
By not having an exit plan, you leave yourself vulnerable to indecisiveness and the possibility of a blow up if you don’t know when and why you should exit.
An exit plan should be based on:
- knowing what price you want to sell
- or whether to use a stop loss
- when to scale back a position
- when to add to a position
Sin #2: Not Having an Entry Plan
Not having an entry plan is also a deadly sin.
This sin creeps in when you buy stocks based on feelings. The difference between a good and bad investment always comes down to the price you pay.
When it comes to buying a home, people will spend weeks and months searching for the right home and waiting for the right price.
But with intangible assets like stocks, most people will throw in money without thinking about the valuation or the future of the business.
An entry plan should revolve around:
- positioning sizing, and
- whether the stock fits your portfolio
Sin #3: Not Reviewing Your Portfolio
I like to set a time every couple of months or so to go through the valuations of each company and decide whether it’s a continued hold, sell or buy.
It’s always much easier to buy more of a company that you already own rather than look for another position to add.
The best investment could be right in front of your nose.
By going through my portfolio once a while, I get to revisit a stock from a fresh perspective and sometimes, I’ve questioned myself, why I bought at a such a price.
Some notes on reviewing your portfolio:
- Don’t review your portfolio daily or weekly as it will be emotion based
- Ask yourself if the stock dropped another 50%, would you buy more?
- Review your valuation inputs that you used to purchase the stock. Does it still make sense?
Sin #4: Personalizing Losses
Honestly, some people don’t. Some people have no right to even touch money.
If you look at histories of successful people, they all dealt with losses and failures remarkably well and objectively. The difference is that they learnt from it and didn’t it take it personally. Thomas Edison said:
I have not failed. I’ve just found 10,000 ways that won’t work.
All great investors failed more than once.
However, they are able to cut losses on investments that don’t work out without letting ego prevent them from doing the right thing.
To avoid personalizing losses:
- Realize when you are making emotional decisions
- Don’t get depressed or saddened
- Take it as a lesson and move onto the next project
Sin #5: Personalizing Successes
On the flip side, personalizing successes is equally deadly.
Henry Ford revolutionized the motor industry but until he was forced to step down, the company lost millions for two decades. His string of early successes led him to believe that he had the Midas touch which prevented him from making objective decisions.
Steve Jobs was kicked out of Apple because he believed he could do no wrong and that his decisions were always the right one.
True to some extent.
But when you believe that your success is proof of future success, it will cause your guard to go down and create plenty of opportunities for it to blow up.
The difficult thing at that point will be to admit that not everything you do is successful.
To avoid personalizing successes:
- Past performance doesn’t guarantee future performance
- Heed the advice of others when necessary
- Put systems in place that will prevent you from getting the Midas syndrome
Sin #6: Placing More Emphasis on Being Right than Making Money
Being right is a moral victory in the stock market.
During the great US recession of 2008, many pundits claimed that they predicted the market crash.
But of those people, how many people actually made money off it?
As far as I know, only two people.
Michael Burry and John Paulson.
This sin makes people focus on being a prophet instead of turning a profit.
The market can continue to go against you much longer than you can remain solvent. If you liquidate a position and 6 months later the market shows that you were right, does it matter that you were right even if you lost money?
What Other Sins Do You Commit?
These are fairly broad sins, but can you see how relatable each one is?
Being human, I’m sure I will commit these sins again but there are certainly more that I haven’t included here.
What are some other sins that you think should be included in this list?
About the AuthorJae Jun is an investment writer at Old School Value, a value investing site empowering individuals with stock valuation tools, tutorials and resources.