Unnecessary Risks and Why Some People Always Lose Money

Why Some People Always Lose Money

Do you like taking unnecessary risks? With money? I am not sure about your answer but mine is that I don’t.

Ofcourse we cannot eliminate the risks in stock market investing. But lower the risks are, better I feel. In previous post about why being smart is not necessary to be rich, I explained why having a super IQ + intelligence might not protect your investments.
We need to understand that we can afford not to be a great investor. But we cannot afford to be a bad one.

The downside of being bad are pretty, bad. There is no need to take unnecessary risks if you don’t know what exactly is being offered in a deal. You can always choose to walk out of a deal you don’t understand fully. Instead, take the 2nd best strategy if that works for you more than the best one. 
I know many cases where people have lost all money in stock markets. Then there are those who are waiting to recover money lost in stocks, even after years (and in rare cases, decade). Even the financial companies at times (rather most of the times) try to fool you. Read thisfor a real-life incident.
And who can forget the IPOs? Designed specifically to not-benefit only one category of people – new investors. 🙂

The promoters know more about their companies than the small investors. They only come out with IPOs when they know that they will be able to sell at prices, which are higher than actual intrinsic value. Now when the prices correct in line with actual value, the small investors get hurt. Then promoters come back with buybacks, open offers and delisting proposals. So all in all, its quite unfair. But people still take the IPO route when they see any recent trend of IPOs doing well.
In secondary markets, most investors participate with the wrong mentality. With share prices going up and down on a daily basis, there is an urge to act and benefit from volatility. But most investors lack the capability to make the right decisions under such levels of uncertainty. They let emotions take control of their portfolio and end up ruining it.

Another reason why some people always end up losing money is that they bet something important to get something unimportant.
Lets take an example.
Suppose you have to send your child to college in 5 years. You know that you will need Rs 15 lacs for that after 5 years. You have already saved up Rs 10 lac and are also regularly saving Rs 7000 a month. This will easily let you achieve the target of Rs 15 lacs in 5 years, even if you don’t earn anything on Rs 10 lac that you have already saved .
But your high-flying, high IQ financial advisor tells you that a particular sector is expected to do well in coming years. And you can benefit from this once-in-a-lifetime-opportunity by investing in some sectoral fund. You think about it and invest the already accumulated Rs 10 lacs in the sector fund.

Unfortunately, the sector doesn’t turn out to be a once-in-a-lifetime-opportunity and your investment goes down to Rs 7 lacs after 5 years.
Result is that you have screwed up the goal of achieving Rs 15 lacs in 5 years because you took an unnecessary risk.
You gambled because of your greed, ignorance or whatever. You risked something important for something that was not.
Buffett once used the example of Long Term Capital Management (LTCM) to explain about taking unnecessary risks. This is what he had to say (emphasis mine):

“…If you take the 16 of them (LTCM’s people), they probably have the highest average IQ of any 16 people working together in one business in the country, including Microsoft or whoever you want to name – so incredible is the amount of intellect in that room.
Now if you combine that with the fact that those 16 have had extensive experience in the field in which they operate. I mean, this is not a bunch of guys who made their money selling men’s clothing and all of the sudden went to the security business or anything. They had, in aggregate, probably 350 or 400 years of experience doing exactly what they were doing.
And then you throw in the third factor: that most of them had virtually all of their very substantial net worth in the business.
They have their own money tied up, hundreds of hundred of millions of dollars of their own money tied up, a super high intellect, they were working in a field they knew, and they went broke.
And that to me is absolutely fascinating.
If I write a book, it’s going to be called “Why do smart people do dumb things?
To make the money they didn’t have and they didn’t need, they risked what they did have and did need – that’s foolish, that’s just plain foolish.
If you risk something that is important to you for something that is unimportant to you, it just does not make any sense.
I don’t care whether the odds are 100 to 1 that you succeed, or 1000 to 1 that you succeed.
If you hand me a gun with a thousand chambers or a million chambers, and there is a bullet in one chamber and you said ‘put it to your temple and pull it’, I’m not going to pull it. You can name any sum you want.
It doesn’t do anything for me on the upside, and I think the downsize is fairly clear.
I’m not interested in that kind of a game, and yet people do it financially without thinking about it very much.
It’s like Henry Kauffman said the other day – the people going broke in these situations are just two types: the ones who know nothing, and the ones who know everything.”


Coming back to the example of funding your child’s education, you can easily blame bad luck for getting screwed up.
But is it really bad luck? I don’t think so.
Its rather a case of what this quote by DW Jerrold says:
Some people are so fond of bad luck that they run halfway to meet it. 🙂

So what is it that takes to save your money from yourself?
There is no set formula to not lose money. Also being smart is a good thing. But don’t be oversmart when it comes to money matters. Don’t do stupid things because you are greedy or impatient.
There are things you don’t know and more importantly, there are things that you don’t know that you don’t know! That is where the biggest risks lie. Make buffers for such unknown-unknowns. Also make buffers for known-unknowns like death.
Be aware of the potential downsides of your decisions. The potential upside is totally irrelevant if the downside is bankruptcy or death (as in case of Buffett’s gun example).
And as David Houke of Alpha Architect says, there are certain bets, regardless of how asymmetric they may appear, that should be beyond consideration by a reasonable and prudent actor. The second thing that can protect you is an awareness of what the potential monetary upside actually means to you, in practical terms.
The second point is really important.

What is that you are after? Does taking the additional risk actually help you in any other way apart from adding some extra money to your wallet? What is the true effect of additional returns on you and your life circumstances? It’s a question worth asking.
So if till now, you have managed to lose money in most of your investments, may be its time to think critically about your thought process, your assumptions, your risk-taking habits and what your financial priorities are.

I Don’t Know. Just Say It.

I Don't Know

Have you ever felt that stock market is rigged to ensure that you never make money? I am sure that many of your friends/relatives who have lost money in markets will tell you this. And this is a very natural feeling to have when one has lost money. After all, the blame has to be put on something…

But have you ever ‘really’ thought why you (or your friends) ‘actually’ lost money in markets?
We will come back to this question in a bit…
I was reading a post by Shane Parrish of FarnamStreet Blog, where he shared a quote from the book How Adam Smith Can Change Your Life. It’s about how and why, recognizing our own shortcomings is the first step in the journey of gaining wisdom.
Now when I say wisdom, I don’t mean that the idea is to become some guru or an investment expert. Rather, its about knowing what mistakes we can make in future, both knowingly and unknowingly. Having the wisdom helps us reduce the chances of making those mistakes. And when it comes to investing, mistakes can have big financial impacts…
So here is the quote (emphasis mine):

As I have gotten older, I have become less confident and maybe more honest. The economy is too complex; we can’t measure the interactions of all its various pieces with any precision.
We don’t have enough data, and we don’t understand how things fit together.
We are drunks looking for our lost keys under a lamppost not because that’s where we lost our keys, but because that’s where the light is.
We should be humbler and more honest.
Our empirical studies are very imperfect. We often hold the views we do because of ideology and principle. Then we find some evidence that supports those views. We ignore the rest…
An awareness of reason’s limits is a caution sign to remind us that we’re not as smart as we think; we’re not perfect truth seekers. We’re flawed.
Recognizing our flaws is the beginning of wisdom.
Many things look like nails that do not benefit from being pounded. That should induce caution and humility for those with hammers … Humility is an acquired taste. Once you come to like it, it’s a dish best served hot.
It’s amazing how liberating it can be to say, “I don’t know.”

Read it?
Aren’t those some really potent and bring-me-back-to-ground words?
Now lets come back to our previous question:
Have you ever thought why you (or your friends) actually lost money in markets?
Lets try answering this question with a few more questions!
Did you invest in companies with bad businesses? Did you even know what businesses the company was in? Did you know what were the demand-supply dynamics of the business? Did you understand the industry/sector in which the company was operating? Did you understand how various economic events affected company’s business?
Or did you invest on basis of a prediction that the government will do something (in future) that will be beneficial for the company. To put it simply, you were betting on a positive consequence of a positive consequence that will become a reality if a prediction came true. 😉 (Best of luck with that)
Or did you simply invest on basis stock tips that you got from your friends or stock broker?
Or did you invest when you knew very well that you needed the money back within few months? (Why you shouldn’t do this?)
I am sure you are getting what I am trying to say here…
Chances are high that you lost money in markets not because market is volatile or rigged, but because you did not do your homework. You lost money not because of market’s behaviour but because of your own behaviour.
Now I know some very smart people, who are absolutely dumb when it comes to managing their money. These people don’t know the limits of their intelligence (or lack of it in certain areas). Some of them are mathematical stalwarts who are so used to using statistical models to predict the future, that they try to use their models anywhere and everywhere. What they forget is that in investing, there are a lot of things that cannot be answered by maths or formulae. As Morgan Housel puts it, “There are things we can’t measure, and things we can’t understand, ever. Herd behavior, future trivia, and psychology aren’t things we can predict today.”
For people who are not willing to accept the limits of their knowledge, there is no world outside the facts they have memorized. Markets are driven more by human behavior than anything else. So if one tries to predict human behavior with standard deviation, etc., then such an approach is bound to be met with failure most of the times.
Realizing the limits of your intelligence is one of the most important skills in finance. When you pretend you know something you don’t, your perception of risk becomes warped. You take risks you didn’t think existed. You face events you didn’t think could occur. Understanding what you don’t know, and what you can’t know, is way more important than the stuff you actually know. [Morgan Housel]
So what should you do?
They say that the best apology is a changed behaviour.
So when markets are being so volatile these days, take some time off and think about your past investing decisions. Instead of just fretting over not being able to make money in markets till now, objectively assess why it really happened?
Did you do that?
If not…then why not?
This then demands the question that do you even know what really works in investing?
If not, then why are you even investing in direct stocks?
Lets for a moment assume that you know what works in investing. Now the question is that are you putting that information to use?
If not…then why not?
What are you waiting for?
If you don’t have the time or skill to analyse individual business, why are you playing the game of direct equity investing? I am not saying that don’t invest in stock markets. After all, it’s a kind of necessity when we think about the returns we need to have to achieve our financial goals.
I am saying that for most people, its best to instead take the MF route as it works beautifully. Allow compounding to help you. It has helped our grandparents, parents and a few of us. It will work for others too. Don’t wait for years thinking whether it works or not.
So take your time.
Sit back and reflect on your own behaviour in past.

Learn from your mistakes and change your behaviour accordingly. Because as they say, best apology is a changed behaviour. And if apologizing results in future wealth creation, why not do it?

The 6 Deadly Sins of Investing

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:
  • valuation
  • positioning sizingand
  • whether the stock fits your portfolio

Sin #3: Not Reviewing Your Portfolio
When I “review” my portfolio, it isn’t looking at the daily stock prices.
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.
But the truth is that most people can easily manage their money and do well. It’s just that most people take the losses personally and it is hard for them to accept. Because in doing so, it makes them look bad.
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 Author
Jae Jun is an investment writer at Old School Value, a value investing site empowering individuals with stock valuation tools, tutorials and resources.