Reducing Opportunity for Mistakes

I’ve just finished going back and looking at the trades I made during this last market dip, to see if they worked to my advantage. I thought I was making solid moves for my portfolio, trimming back some companies that looked overvalued to raise cash to buy up companies that looked overly beaten down. But it turns out I was wrong: my portfolio would be up an additional 1/2 percent today had I simply done nothing (and that doesn’t even include commissions, new tax liability, and other frictional costs).

That’s not to say these won’t be solid long-term changes, and none of them were intended to be short-term trades anyway. But still, I’d be better off making those changes today than I was during the dip. It’s just one more reminder that market timing doesn’t work, even when it appears that opportunity is knocking.

All of us want to invest better and want to know what we can do to better maximize our returns. But ultimately, I don’t think successful investing is about maximizing returns so much as it’s about minimizing mistakes. And I’ve come to realize that a big part of minimizing portfolio mistakes is about minimizing decisions.

The simplest investment decision you can make is to just toss all of your money into an index fund. You know that, over the long term, it will do well. Not as well as Saul, of course, but well enough for most folks. Every additional decision we make carries the risk of making an error and letting our human biases creep in. The more decisions, the more risk. This is why trading in and out of stocks doesn’t work: while sometimes we win, overall our mistakes add up to be too many or too severe, and the end result is destruction of either wealth or opportunity or both.

When you look at the best investors, you will usually find that they follow a set of rules and processes. Saul avoids Chinese companies. Buffet avoids tech companies. Those rules aren’t there to maximize profit, but to minimize mistakes. You can say “But Saul, look at all that profit you missed out on with Baidu!” And “Warren, look at all that profit you missed out on with Apple!” And sure, Saul has undoubtedly missed out on tremendous opportunity, and yet his long-term returns are astounding nevertheless. Buffet has missed out on billions – probably trillions – of dollars of opportunity. But he’s still the 3rd richest person in the world, so does it really matter? Missed opportunity is a red herring.

There are, of course, few hard and fast rules in investing. There are a lot of established styles, and most of them are successful for some people. We talk a lot about finding the style that matches your temperament, but what we really are saying is finding a process that will lead you, personally, to make fewer long-term mistakes. We talk about temperament because most of our mistakes are driven by emotion, and so finding a style that helps us work with our emotions, rather than against them, can have a real positive impact over the long run.

Ultimately, I believe we have a tendency to over-complicate investing. As Buffet said, “Success in investing doesn’t correlate with I.Q. once you’re above the level of 25. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.”

So stop lamenting all the money you could have made – it’s irrelevant – and instead just focus on what you can do to minimize your investing mistakes. What processes do you need to put in place? What rules do you need for yourself to check your emotions? It could be as simple as Buffet’s ticket punch:

I could improve your ultimate financial welfare by giving you a ticket with only twenty slots in it so that you had twenty punches - representing all the investments that you got to make in a lifetime. And once you’d punched through the card, you couldn’t make any more investments at all. Under those rules, you’d really think carefully about what you did, and you’d be forced to load up on what you’d really thought about. So you’d do so much better.

If you had never made an unforced investing error – never chased that hot stock you knew nothing about, never sold out of that great business because it looked overvalued, never lost patience with that misunderstood gem – what might your returns be like today?

We’re all going to make mistakes, of course. I assure you these won’t be my last :wink: But perhaps, in addition to assessing ourselves honestly from time to time and working on reducing our future mistakes, we should also be thinking about reducing the opportunities for mistakes to be made at all.

Neil

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Hear hear!

Thank you for sharing your thoughts.

210314aqua

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Neil, great post!
Saul

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Neil,
I thought that your note was so relevant, and so thoughtful - that I have printed it and stuck in my investing book. Thank you for all that you do on the boards.
tracyll

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But ultimately, I don’t think successful investing is about maximizing returns so much as it’s about minimizing mistakes. And I’ve come to realize that a big part of minimizing portfolio mistakes is about minimizing decisions.

neil;

Well said. This translates very well to David G’s philosophy - buy into good businesses and hold them for a long time. Time should be spent to assess the business but not worry too much about day-to-day price changes or even q-to-q earnings. Buy into companies for long-term prospects not for short-term catalysts.

-M

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neil

Post of the Day and maybe even of the month. This was really good

Avoiding spectacular mistakes is key to better returns and is something we don’t think enough about.

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Great post!

On the same topic, I recently read this book and it has a lot of good info to help look critically at some of the spaces where we each may trip ourselves up.
Figured I’d share because I enjoyed it.

http://www.amazon.com/Learned-Million-Columbia-Business-Publ…

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Yeah, hopefully we all try to learn from our experiences and mistakes. I think it really begs the question: what is a mistake? It is a poor past decision? And how do we recognize a mistake? Hopefully, we can recognize the difference between a good decision that didn’t turn out well versus a poor decision from which we profited. Also, something that may appear to have been a mistake may not be one.

I think we need to be careful when classifying a past action a mistake. We really need to be clear on why something was a mistake or not. Having rules really helps and deviating from such rules may later lead us to classifying something a mistake.

Let’s take some examples. Since we all follow Saul, let’s look at a couple of Saul’s actions (Saul, this is not intended to pick on you but rather an example that most people here will be aware of).

#1 Saul has a rule not to invest in companies without earnings. He sometimes makes exceptions but when he does so he only invests small allocations. SZYM was an exception and he made that investment fully aware of this fact. Now, SZYM’s latest earnings announcement and the facts that came out during the conference call really changed the prospects. So was investing in SZYM a mistake by Saul? He did so fully aware. It didn’t turn out well. Based on Saul’s reaction, I think he will be more careful when investing in non-profitable companies. He may still invest in some in the future but he may be more stingy with the allocation.

#2 Saul has a rule not to invest more than 10% in any one company. Over the past months, I have observed Saul increasingly bending this rule with several of his positions. Again, he is doing so knowingly and he has strong conviction in these companies. So is he making a mistake or is he changing his rules? Maybe the future outcome of earnings of these companies will determine is breaking the rule was a mistake or a good decision. Maybe the outcome will also lead to a more strict adherence to the rules or to continued bending of them.

My point is that we should be careful about evaluating out past decisions. There are good decisions with good results, good decisions with bad results, bad decisions with good results, and bad decisions with bad results. The better we are at understanding the difference, the better we will be at making good future decisions.

Chris

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And how do we recognize a mistake?

I don’t necessarily call a loss a mistake. We are all going to have losses. If there was something we did wrong. Or incomplete. Or hurried. Etc… That is a mistake.

Simply put, a mistake is a flaw in the process. The good news is we can fix those.

Jeb

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Yeah, hopefully we all try to learn from our experiences and mistakes…How do we recognize a mistake? Hopefully, we can recognize the difference between a good decision that didn’t turn out well versus a poor decision from which we profited… I think we need to be careful when classifying a past action a mistake. We really need to be clear on why something was a mistake or not. Having rules really helps and deviating from such rules may later lead us to classifying something a mistake. Let’s take some examples. Since we all follow Saul, let’s look at a couple of Saul’s actions…

#1 Saul has a rule not to invest in companies without earnings. He sometimes makes exceptions but when he does so he only invests small allocations. SZYM was an exception and he made that investment fully aware of this fact. Now, SZYM’s latest earnings announcement and the facts that came out during the conference call really changed the prospects. So was investing in SZYM a mistake by Saul? He did so fully aware. It didn’t turn out well. Based on Saul’s reaction, I think he will be more careful when investing in non-profitable companies. He may still invest in some in the future but he may be more stingy with the allocation.

#2 Saul has a rule not to invest more than 10% in any one company. Over the past months, I have observed Saul increasingly bending this rule with several of his positions. Again, he is doing so knowingly and he has strong conviction in these companies. So is he making a mistake or is he changing his rules? Maybe the future outcome of earnings of these companies will determine (whether) breaking the rule was a mistake or a good decision. Maybe the outcome will also lead to a more strict adherence to the rules or to continued bending of them.

My point is that we should be careful about evaluating out past decisions. There are good decisions with good results, good decisions with bad results, bad decisions with good results, and bad decisions with bad results. The better we are at understanding the difference, the better we will be at making good future decisions.

Wow! Chris, you really hit some great points and great ways of thinking about it. And you were absolutely correct about my decisions. When I invested in SZYM a year ago, I made an exception because it sounded as if they had these two huge factories coming on line within two quarters, which would change the company from a money losing development company to a profitable producing company. It didn’t happen as they thought and they are having to make emergency downsizing changes to their plans with no endpoint in sight. Not necessarily a mistake, but rather a decision which didn’t work out. And probably one I’d be loathe to repeat.

And I have let BOFI, especially, as well as a couple of others, drift upward as a proportion of my portfolio to levels beyond my rules. As you pointed out, BOFI is a very high conviction stock with very reliable results, and a PE under 20. You might want to read Fletch’s write-up on it on the BOFI board on MF RB’s. He posted it earlier today and has over 50 recs already. (I’ve asked him if I can repost it here.)

Thanks for a great post.

Saul

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Nice post. Got burned this year on the one and only purely macroeconomic I can remember making, a gold short. Still don’t know why I did it, still not sure what went wrong. Just some theories.

And a good reminder of Buffett’s advice to avoid the macroeconomic noise, as an investor. Felt great to pull the trigger and finally admit I was wrong and the thesis was wrong. Really not that hard. Next.

Glad they have Post of the Day, otherwise I would have missed your great post.

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Neil, nice thought out post. Your point about minimizing mistakes should be taken to heart by all because that is truly the object of the game. My biggest mistakes are selling out to early and not letting my winners run, ie Tesla, Netflix. The decision to sell is always the hardest for me, I usually hold my losers longer hoping for a rebound and sell my winners to soon. I hope to learn to minimize my mistakes but it is a work in progress. Thanks for your intelligent post.

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Thank you neil for a thoughtful post.
I love this board. There is so much to learn as I am figuring out my style.
can i get access to this board if i was only subscribing to SA.
currently I am a million dollar subscriber but having serious second thoughts.
I don’t want to miss this board if I cancel my million dollar subscription
Thanks again to every one here.
usha

Hi Usha,

It’s one of the free community boards, so you don’t need any premium subscription to access it.

Neil

Thank you
usha