By Tom Bradley
The Globe and Mail, Report on Business
Published September 29, 2007
"Wisdom comes from sitting on your ass."
According to Warren Buffett's sidekick, Charlie Munger, it's the best road to effective thinking.
For the last six weeks I've been laid up while recuperating from surgery (a friend noted that I'd picked a great time in the market to be "seriously sedated"), so I've been able to put Charlie's thesis to the test. I've spent considerable time sitting on my ass, or should I say, doing some deep, reflective thinking.
As I read and think and read and think, there is one question that has been rattling around in my head. Why is it that investors, both amateur and professional, keep making the same mistakes year after year and cycle after cycle?
The mistakes I'm referring to are not the small, micro decisions (for example, Telus v. Bell, Chou v. Brandes), but the big, incontrovertible stuff.
We chase past performance.
Everyone does it to some degree, even the most savvy of investors. We take comfort in recent success. Money managers that are at the top of the charts for one-to-three-year performance look smarter than their competition. We want to invest with the best, so we gravitate towards these managers. Rarely do we take our research a step further to assess whether their record is sustainable or their approach makes sense for the years ahead.
We think it is possible to reliably forecast what the future will bring. This perpetual mistake manifests itself in two ways.
First of all, we think there are people or firms out there who have it all figured out. We believe the Jeff Rubins and Eric Sprotts of the world know what interest rates, commodity prices or the stock market are going to do next.
And second, we delude ourselves into thinking that we are good at forecasting the future.
In reality, the record is poor for both the experts and at-home investors. Given the complexity of the world around us, nobody can reliably predict where the capital markets will be a year or two from now. And we are all prone to basing our predictions too heavily on what is happening today.
We expect high returns without taking any risk.
The industry's marketing machine is largely responsible for this mistake. We are constantly barraged with advertisements telling us we can achieve attractive returns with little or no risk. Even if we know deep down that higher returns can only come from taking risk and experiencing more volatility, we get worn down to thinking there is a better way.
From my experience, the biggest mistakes are made when pursuing supposed "high return/low risk" investments.
We are ill-prepared for the down drafts.
We don't know when the next Black Monday, Asian crisis or credit crunch will come, but we know for sure that it will. It will occur some time between tomorrow and five years from now. Unfortunately, when it does arrive we'll be like a deer in the headlights, acting fearful (hesitant) when we should be greedy (aggressive).
This mistake is unfortunate because investors who are still building their portfolio (as opposed to drawing on it) should be jumping out of their shoes with excitement when markets are down and people are running for the hills. Stocks, bonds and mutual funds are on sale. What could be better than buying a really good fund, that has an experienced, long-standing manager, when its unit value is down? It's a beautiful thing.
We overdiversify our portfolios.
We identify a fund manager or a few individual stocks that we really like, and then we proceed to dilute their impact by adding a bunch of other securities that we don't feel nearly as strongly about. Fund managers do this when they hold too many stocks and their portfolios start to reflect the index they're competing against. Individuals do it by stuffing too many investment products in their account. In identifying this as a mistake, I'm not suggesting that diversification isn't a valuable investment tool, but we go well beyond what is required to achieve the benefit.
And the final one I'll mention is a biggie.
We evaluate long-term investments based on their short-term results. We buy for the right reasons, but aren't patient enough to let the scenario play out. This happens with stocks and mutual funds. In both cases, management might be making all the right moves, but the strategy is taking time to gain traction. By the time the payday comes, however, we have sold the stock or redeemed the fund.
Why do investors keep making the same mistakes over and over again? I don't know yet. I haven't been sitting on my ass long enough.