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The Seven Deadly Investment Sins

MOST INVESTORS ARE HURT BY mistaken beliefs about how to achieve investment success. These are beliefs that Master Investors such as Warren Buffett, George Soros, and Carl Icahn don’t share. The most widely held of these damaging falsehoods are what I call The Seven Deadly Investment Sins.

The first step in putting these mistaken notions behind you is to see what’s wrong with them …

DEADLY INVESTMENT SIN NO. 1

Believing that you have to predict the market’s next move to make big returns.

REALITY:

Highly successful investors are no better at predicting the market’s next move than you or I.

Don’t take my word for it.

One month before the October 1987 stock market crash, George Soros appeared on the cover of Fortune magazine. His message:

“That [American] stocks have moved up, up and away from the fundamental measures of value does not mean they must tumble. Just because the market is overvalued does not mean it is not sustainable. If you want to know how much more overvalued American stocks can become, just look at Japan.”1

While he remained bullish on American stocks, he felt there was a crash coming … in Japan. He repeated that outlook in an article in the Financial Times of October 14, 1987.

One week later, Soros’s Quantum Fund lost over $350 million as the US market, not the Japanese market, crashed. His entire profit for the year was wiped out in a few days.

As Soros admits: “My financial success stands in stark contrast with my ability to forecast events.”2

And Buffett? He simply doesn’t care about what the market might do next and has no interest in predictions of any kind. To him, “forecasts may tell you a great deal about the forecaster; they tell you nothing about the future.”3

Successful investors don’t rely on predicting the market’s next move. Indeed, both Buffett and Soros would be the first to admit that if they relied on their market predictions, they’d go broke.

Prediction is the bread-and-butter of investment newsletter and mutual fund marketing—not of successful investing.

DEADLY INVESTMENT SIN NO. 2

The “Guru” belief: If I can’t predict the market, there’s someone somewhere who can—and all I need to do is find him.

REALITY:

If you could really predict the future, would you shout about it from the rooftops? Or would you keep your mouth shut, open a brokerage account, and make a pile of money?

Elaine Garzarelli was an obscure number cruncher when, on October 12, 1987, she predicted “an imminent collapse in the stock market.” That was just one week before October’s Black Monday.

Suddenly, she became a media celebrity. And within a few years, she had turned her celebrity status into a fortune.

By following her own advice?

No. Money poured into her mutual fund, reaching $700 million in less than a year. With a management fee of just 1%, that’s $7 million smackeroos a year. Not bad. She also started an investment newsletter that quickly grew to over 100,000 subscribers.

The business benefits of guru status made plenty of money for Elaine Garzarelli—but not for her followers.

In 1994, the shareholders of her mutual fund quietly voted to shut it down. The reason: lackluster performance and an eroding asset base. Average return over the life of the fund: 4.7 percent per annum, vs. 5.8 percent for the S&P 500.

Seventeen years after she first rocketed to the investing public’s attention, Elaine Garzarelli still maintains her guru/media celebrity status—even though her fund tanked, her newsletter went out of business, and her overall track record of prediction has been dismal.

For example, on July 21, 1996, with the Dow at 5452, she was reported as saying the Dow “could go to 6400.” Just two days later she announced: “The market could fall 15 percent to 25 percent.”

That’s called having fifty cents each way.

Those were two of her fourteen public predictions between 1987 and 1996—as recorded by the Wall Street Journal, Business Week, and the New York Times. Of the fourteen predictions, a mere five were correct.

That’s a 36 percent success rate. You could have done better—and made more money—by flipping a coin.

Elaine Garzarelli is just one of a long line of market gurus who came and went.

Remember Joe Granville? He was the darling of the media in the early 1980s—until, when the Dow was around 800 in 1982, he advised his followers to sell everything and short the market.

Well, 1982 was the year the great bull market of the 1980s began. Nevertheless, Granville continued to urge people to short the market … all the way up to 1200.

Granville was replaced by Robert Prechter, who—unlike Granville—had predicted a bull market in the 1980s. But after the crash of 1987 Prechter declared the bull market finished and predicted that the Dow would plunge to 400 in the early 1990s. That’s like missing the side of a barn with a double-barreled shotgun.

The dot.com boom of the 1990s produced another set of media heroes, most of whom disappeared from view soon after the NASDAQ began tanking in March 2000.

If someone actually exists who can make accurate market predictions consistently, he or she has escaped the relentless hunt for such people by the world’s media. The sage Anonymous was right on the money when he said: “Prediction is difficult, especially when it concerns the future.”

Media gurus make their money from talking about investments, selling their advice, or charging fees to manage other people’s money. But as John Train put it in The Midas Touch, “The man who discovers how to turn lead into gold isn’t going to give you the secret for $100 a year.”4 Or give it to you for nothing on CNBC.

That’s why Buffett, Soros, Icahn, and other Master Investors who make money from actually investing rarely talk about what they’re doing or how they are thinking about the market. Quite often, they won’t even tell their own investors what’s happening to their money!

DEADLY INVESTMENT SIN NO. 3

Believing that “inside information” is the way to make really big money.

REALITY:

Warren Buffett is the world’s richest investor. His favorite source of investment tips is usually free for the asking: company annual reports.

George Soros earned the title of “The Man Who Broke the Bank of England” when he took a massive $10 billion short position against the pound sterling in 1992.

He wasn’t alone. The signs that sterling was on the brink of collapse were there for anyone who knew how to look. Hundreds, if not thousands, of other traders also cleaned up when the pound plummeted.

But only Soros jumped in with both feet and took home $2 billion in profits.

Now that they are famous, Buffett and Soros have ready access to highly placed people. But when they began investing, they were nobodies and could expect no special welcome. What’s more, both Buffett’s and Soros’s investment returns were higher then, when they were unknown, than they are today. So if either now draws on insider information in any way, it clearly isn’t doing him much good.

As Buffett says, “With enough inside information and a million dollars you can go broke in a year.”5

DEADLY INVESTMENT SIN NO. 4.

Diversifying.

REALITY:

Warren Buffett’s amazing track record comes from identifying a half dozen great companies—and then taking huge positions in only those companies.

According to George Soros, what’s important is not whether you’re right or wrong about the market. What’s important is how much money you make when you’re right about a trade and how much money you lose when you’re wrong. The source of Soros’s success is exactly the same as Buffett’s: a handful of positions that produce huge profits that more than offset losses on other investments.

Diversification is the exact opposite: Having many small holdings assures that even a spectacular profit in one of them will make little difference to your total worth.

Highly successful investors will all tell you that diversification is for the birds.

But that’s not a message you’re likely to hear from your Wall Street advisor.

DEADLY INVESTMENT SIN NO. 5

Believing that you have to take big risks to make big profits.

REALITY:

Like entrepreneurs, successful investors are highly risk averse and do everything they can to avoid risk and minimize loss.

At a management conference a few years ago, one academic after another presented papers on “the entrepreneurial personality.” The academics pretty much disagreed with each other except on one thing: Entrepreneurs have a high tolerance for risk and, indeed, most love taking risks.

At the end of the conference, an entrepreneur in the audience stood up and said that he was flabbergasted by what he had heard. As an entrepreneur, he did everything he could to avoid risk, he said. He also knew many other successful entrepreneurs and said it would be hard to find a bunch of people anywhere who were more risk averse.

Just as successful entrepreneurs are risk averse, so are successful investors. Avoiding risk is fundamental to accumulating wealth. Contrary to the academic myth, if you take big risks you’re more likely to end up making big losses than banking giant profits.

Like entrepreneurs, successful investors know it’s easier to lose money than it is to make it. That’s why they pay more attention to avoiding losses than to chasing profits.

DEADLY INVESTMENT SIN NO. 6

The “System” belief: Somebody, somewhere has developed a system—some arcane refinement of technical analysis, fundamental analysis, computerized trading, Gann triangles, or even astrology—that will guarantee investment profits.

REALITY:

This is a corollary of the “Guru” belief—if an investor can just get his hands on a guru’s system, he’ll be able to make as much money as the guru says he does. The widespread susceptibility to this Deadly Investment Sin is why people selling commodity trading systems can make good money.

The root of the “Guru” and “System” beliefs is the same: the desire for a sure thing.

As Warren Buffett responded to a question about one of the books written about him in a scathing tone of voice: “People are looking for a formula.”6 They hope that by finding the right formula, all they’ll have to do is plug it in to the computer and watch the money pour out.

DEADLY INVESTMENT SIN NO. 7

Believing that you know what the future will bring—and being certain that the market must “inevitably” prove you right.

REALITY:

This belief is a regular feature of investment manias. Virtually everyone agreed with Irving Fisher when he proclaimed: “Stocks have reached a new, permanently high plateau”—just a few weeks before the stock market crash of 1929. When gold was soaring in the 1970s, it was easy to believe that hyperinflation was inevitable. With the prices of Yahoo, Amazon.com, eBay, and hundreds of “dot-bombs” rising almost every day, it was hard to argue with the Wall Street mantra of the 1990s that “Profits don’t matter.”

This is a more powerful variant of the first Deadly Investment Sin, that you have to be able to predict the future—but far more tragic.

The investor who believes he must be able to predict the future in order to make money searches for the “right” predictive method. The investor who falls under the spell of the Seventh Deadly Investment Sin thinks he already knows what the future will bring. So when the mania eventually comes to its end, he loses most of his capital—and sometimes his house and his shirt as well.

Of all the Seven Deadly Investment Sins, coming to the market with a dogmatic belief is by far the most hazardous to your wealth.

Beliefs Are Not Always Enough

While the wrong beliefs will inevitably lead you astray, having the right beliefs isn’t always enough.

For example, when I was researching the IceBreaker’s strategy, one of my subjects was a charming Frenchman who was at ease talking to complete strangers. Like the IceBreaker, he believed that all people are interesting. Nevertheless, he still had to wait for a context, like being at a party or sitting at the same cafeteria table, before he felt able to start a conversation.

The moment I taught him the IceBreaker’s mental strategy of hearing his own voice saying “Isn’t he/she an interesting person,” his need to wait for a context disappeared, and he began talking to every stranger who passed by.

So each element of the structure of a mental habit—the belief, the mental strategies, the sustaining emotion, and the associated skills—must be in place for any mental habit to become your own.

The Holy Grail of Investing

When I entered the investment arena in 1974, I knew nothing about mental habits and strategies, but I was a committed practitioner of all Seven Deadly Investment Sins.

As a publisher of the World Money Analyst and as a goldbug riding the inflationary waves of the 1970s I achieved minor guru status myself.

But I eventually discovered that …

• Of the dozens of fellow market gurus I got to know, none was any better at making predictions than I was.

• None of the fund managers I met was any good at making predictions either; and almost none of them consistently made money for their investors—or consistently beat the market, for that matter.

One of them partially let the cat out of the bag when I asked him why, since he was so good at making predictions (at least, according to his own marketing), he didn’t just trade for himself rather than manage other people’s money.

“No downside risk” was his answer. “When I manage money, I get 20 percent of the profits. But I don’t share in the losses.”

Another fund manager—hired at an enormous salary just after his fund tanked—completed the picture when his new employer stressed in an interview that the manager’s “recent [dismal] fund performance wasn’t nearly as important as his ability to pull new money into the funds he had overseen.”7

• I’d met people who made their money selling investment and trading systems but who wouldn’t dream of using those systems themselves. Every eighteen months or so they’d be back on the market with a new system—another one they didn’t use.

• I’d developed my own system of making predictions (which I trumpeted in my marketing, of course) which worked for a while and then stopped working altogether when the era of free-floating currencies began.

I started to think that, perhaps, the search for some holy grail of investing was futile.

Paradoxically, it was only after I’d given up the search entirely that I came across the answer—and found that I’d been looking in the wrong place all along.

The problem wasn’t ignorance. It wasn’t something I didn’t know. The problem was me: the poor mental habits I applied to my investment decisions.

Only when I changed my mental habits did I discover how easy it really is to consistently make money in the markets. That’s what will happen to you when you adopt the Winning Investment Habits of Warren Buffett and George Soros.

When you first stepped into the investment arena you brought with you all the unexamined habits, beliefs, and mental strategies you’d built up over a lifetime. If they’ve been working for you, helping you make and keep money, then you’re one of the lucky few.

For most of us, the mental habits we picked up somewhere—who knows where?—as we grew up have cost us, not made us, money.

And if we drifted into any of the Seven Deadly Investment Sins, we unknowingly picked up some extra bad habits to add to any we already had.

Changing your mental habits isn’t always easy—just ask any smoker. But it can be done. And the first step is to discover the habits we should adopt.