By now, I think some of you may have a very long list of complaints about this book. Everyone knows that past performance is no guarantee of future outcome but, then again, we cannot rely on forecasts either. We should not be too short-term oriented and trade too much, but neither should we be too stubborn and stick to a losing investment for too long. The markets are constantly changing and what has worked in the past may suddenly stop working. Yet, you tell us that we should learn from past experiences to increase investment success. And so on.
There are a lot of seemingly contradictory observations and recommendations in this book. However, as I pointed out at the beginning, the selection of mistakes is rather eclectic because they are based on my personal experience as both an investor and adviser. Not everybody makes all of the mistakes described in this book (well, except maybe me), nor do we make these mistakes all the time.
That’s why this collection of common mistakes is only the start. Next, you’ll need to adapt the recommendations for your personal needs – this will require a little introspection.
The first, and most important, step to becoming a better investor is to take an honest look at your investments and your personality as an investor. The best way to do this is to look at past investments. Go back and look at your portfolio. Are there any systematic biases or tendencies? This can be both positive and negative.
If you do not already identify with a specific investment strategy or philosophy, you might want to check if you are more of a growth-oriented or value-oriented investor, if you are more of a trader or someone who sticks with investments for many years. Are you more driven by macroeconomic events and stock fundamentals, or price action and technical signals?
There is no right or wrong answer. As I said in Chapter 7, what makes markets tick is the divergence of opinion, and the interaction between different types of investors. Thus, all kinds of different investment approaches can lead to success. Don’t let anyone tell you that chart analysis does not work, or that value is dead. If you look at financial markets as complex dynamic systems, you know that there are no such absolutes. In fact, in my career, I have met people who are consistently successful with chart analysis, macro-driven investing, value investing and a pure, quant-driven approach. If you do it right, you can be successful.
However, what I also see too often is that investors switch from one philosophy to another, or constantly chase the latest trend in investing. Often, these investors lose faith in their current investment approach after a short period of underperformance or losses.
One company I used to work for checked how often private investors changed the investment risk profile that determined their strategic asset allocation. They found that, on average, it happened every 18 months. This is a deadly mistake, as an investment strategy is something that needs to prove itself over five years or more. Changing it after one and a half years is clearly too short-term oriented. There is no investment approach that I know of that can be assessed over such a short time frame, or that can be expected to work over such a time frame all the time.
So, if you don’t have an investment strategy yet, look at your portfolio and see if you can identify some tendencies in your investments. These tendencies might give you an idea of what kind of investment philosophy you are most drawn to. Most private investors, and certainly all professional investors, already have a specific investment philosophy they try to implement. Once you have a certain investment philosophy or strategy, your job is to look at your past investments and identify things you did well and things you did not do so well.
For example, if you follow a value investment style, the requirements for success are to be able to deviate from the herd and position yourself against current market trends. If you don’t feel comfortable being a contrarian – an outsider in the eyes of mainstream investors – you will not be able to summon the patience and grit necessary to hold on to a value investment as markets go through boom phases.
If you are able to hold on to investments for a long time, even as market sentiment is seemingly moving against you, be aware that there are risks to holding on for too long. So, look at your past investments and see if your discipline in selling investments is as good as your discipline in holding on to them. Did you fall into value traps in the past? If so, what techniques in this book can help you avoid these traps in the future?
On the other hand, you might be a more trading-oriented investor, who relies a lot on trend-following techniques and chart analysis. If this is the case, you should be able to emotionally disconnect yourself from your investments and not get too attached to your portfolio. If you don’t, you might hang on to a losing investment for too long as it accumulates losses.
If you want to marry your investments, you are likely going to be a bad trader. However, if you are able to get in and out of investments quickly, without much regret, you need to remember that there are risks to overtrading, and that transaction costs can quickly eat up your profits in the long run.
Furthermore, a common mistake of chart analysis is to use different indicators and trading patterns at different times. You might buy an asset because it breaks through resistance, with the goal of selling it once it reaches the next resistance level, but once you are there, argue that the asset isn’t overbought yet because the RSI indicator is only at a reading of 50.
Consistency is the key and switching from one indicator to another is likely to cost you a lot of money at some point in the future. In fact, what you are doing is falling prey to confirmation bias, so you might want to go back to Chapter 5 and read about the techniques I described there.
Once you have identified your investment philosophy, and have a basic understanding of your strengths and weaknesses as an investor, it is time to implement a learning and self-improvement loop in your investment process. In my experience, it is advantageous to start with an investment checklist that describes the basic steps you make before any investment decision.
In the beginning, this investment checklist will likely be very short, but, over time, it will become more granular and detailed. The way to improve yourself and your investment success has been described in Chapter 4. The interplay between an investment checklist and an investment diary leads to a constant evolution of your investment approach. Every investment decision you make will help you get to know yourself a little better, as well as understand your strengths and weaknesses.
If you use investment diaries and investment checklists properly, then your investment process should gradually shift towards a process that emphasises your strengths and limits the negative impact of your weaknesses. But, don’t expect that you will be able to eliminate your weaknesses or avoid mistakes altogether. That is simply not possible.
As I showed in Chapter 7, markets change all the time, which means that you will inevitably invest in assets that will lose money. If you can’t live with that, then maybe investing doesn’t suit you. You may be better served by handing your money to a professional, who will try to manage it for you as best they can.
To give you an idea of how this evolution looks, let me show you how my investment checklist for forecasts has developed over time. As I discussed in Chapter 1, forecasts over time frames of one year or so tend to be highly unreliable, and the accuracy of any forecast you can make in financial markets is much lower than you might expect it to be.
Of course, at the beginning of my career, I thought I could make forecasts for stocks – so I made the same mistake as most analysts and investors. After a while, I recognised how futile this was; that no matter how sophisticated my models would become, the uncertainty around my forecasts would still be enormous. So, I took a step back, and started with a simple checklist on how to make forecasts.
My primary rule is:
Do not make point forecasts, only directional forecasts.
Or, as someone once put it: “You should only forecast what is going to happen or when something is going to happen, but not both at the same time.” The rule I started with was very crude and in need of improvement. So, as I made forecasting mistakes, I noted them down in my investment diary. When I came to check my diary once a year, I used this information to amend and revise my forecasting rule a little bit.
On top of that, I read great books on forecasting that provided additional insights. After years of tinkering with my forecasting rules, they currently look like this (I have added a few explanations to each rule for clarity):
Corollary A: Torture the data until it confesses, but don’t fit the data to the story.
Corollary B: Start with base rates (i.e. the historical average rate at which an event happens). The assumption that nothing changes, and an event is as likely in the future as it was in the past, is a good starting point, but not the end point. Adjust this base rate with the information you have at the moment.
Continuous improvement will tailor your investment process to your strengths and weaknesses and, in the long run, you will end up with an investment process that fits you and only you. It will be like a bespoke suit or dress: it will look great on you and miserable on everybody else. It will make you feel truly special.
But don’t expect this process of continuous self-improvement to ever stop. The moment you stop improving, you are vulnerable to changes in markets and becoming stuck in the past. You might want to review Chapters 4 and 7 to see what this can lead to in your investment portfolio.
Part of the joy of investing is that there is always something new to learn, and that, although some mistakes are common, the remedies and tools to avoid them change all the time. If I had written this book five or ten years ago, I would have given you different advice, recommending different tools and techniques. And I am sure that if I write this book in five or ten years, the recommendations would differ again. What I have done here is give you the best advice I can with my current knowledge and experience.
I make no guarantees that the tools and techniques discussed here work all the time, but I can assure you that they have helped to make me a better investor. I am pretty confident that these tools and techniques will work for you as well, because I am not special. I am not an investment genius, or supremely skilled. I am not particularly rational as an investor, nor am I particularly skilled at identifying investment opportunities. I am normal, and that means I need a lot of training and improvement to become a competitive investor.
Over the last two decades of my career as an investor, I had the help of many great mentors and experienced investors who taught me valuable lessons in investing. I also had a passion for investing that made me stick to the profession – even through prolonged periods of miserable performance and a lot of criticism from my clients (not to mention the dreadful decline in my lifetime savings).
In a way, this book, with its tools to avoid common mistakes, is my way of helping the next generation of investors to learn and improve at a quicker pace than I did. So, as you finish the book, I hope you will consider this not an end, but a beginning. The beginning of a fun ride in financial markets with the goal of becoming a better investor. Over to you and enjoy the ride!