Avoiding Investment Blunders

James Grant CPA MS

• Éditeur: Page Publishing, Inc.
• Année: 2022
• ISBN:
  9781681392318
• Sujet: Business
• Sous-sujet: Financial Risk Management

There are two parts to the investment equation: (1) How to make money from investing and (2) how to avoid losing it. This book deals with the second objective.

Investors can prosper from small mistakes because they teach valuable lessons, but large mistakes (blunders) wipe out large amounts of capital and ruin lives. Blunders result in lost opportunities, children not going to college, or retirement being postponed or permanently abandoned. Severe losses can produce depression, failed marriages, and even suicide.

How do investors stumble into blunders? They are not prepared, and they are ill-informed. They invest in inappropriate investments, and their timing is bad. They listen to bad forecasts by economists, portfolio managers, CEOs, journalists, and security analysts. Just because an investment product exists does not mean it should be bought. Some investments like mortgage bonds and variable annuities are structurally flawed and too dangerous for average investors.

Blunders occur as a result of misleading statements by the media. They also occur due to scams. Investors are way too gullible and greedy. The investment landscape is treacherous, and it is important for investors to pay attention and employ healthy amounts of skepticism. Investors must employ less emotion and more reason. Investing is not a hobby!

There are many resources to guide investors on how to make money in investing, but there are few guides on how to avoid losing money. The information deficit in Avoiding Investment Blunders is significant. This book contains detailed guidance and occasional colorful examples of the author s missteps and the mistakes of others.

Investment blunders are, therefore, financial disasters that must be avoided at all cost. Investment blunders usually only happen once per person per lifetime. This book will help ensure that blunders do not happen at all!

 

Part I 

The Enemy Within 

Chapter 1

The Nature of Blunders

No matter how brilliant the investor, sooner or later nearly everyone encounters or commits a serious investment blunder. Perhaps the investor fails to fully evaluate management’s credentials for honesty and integrity and experiences a 100 percent loss due to a fraudulent scheme. Alternatively, perhaps the timing of an investment decision is poor, and a security declines sharply in value soon after its purchase. Perhaps an investor simply makes an error evaluating a company’s prospects, and a small loss becomes a large loss because the investor is unable to face reality and acknowledge the loss.

All these blunders are different. In the first instance, the investor’s error was misplaced trust and perhaps an excessive amount of greed. In the second type of blunder, the investor lacked technical knowledge of timing in order to optimize entry (purchase) points and exit (sale) points. In the third example, the investor committed two other blunders. First, the investor lacked discipline to quickly sell a loser, and second, the investor lacked knowledge of the findings from the behavioral school of finance regarding overconfidence.

Investment blunders can be classified. While such an understanding of blunders seems irrelevant, a classification system helps to define the types of blunders that can occur and how to stop them. Most blunders begin with good intentions and modest hopes and ultimately end in disaster. In almost all blunders, it is easy to see the presence of greed and an overly trusting nature. Indeed, trust may be the most important factor in causing the blunder.

A classification system also helps to understand the various risks encountered in every investment decision. In almost all blunders, investment education and experience (a lack thereof) is another important ingredient in preventing a blunder. Investment education and experience must sometimes be extensive in order to reduce or eliminate the risk of serious investment error.

The Classification of Blunders

The following classification system captures the majority of possibilities. The reader will notice that in each instance there is a conflict present. One area is overemphasized at the expense of the other. The investor, in other words, is out of balance when both aspects are not considered.

• Emotional vs. Rational Blunders

This is a left-brain, right-brain conflict. The investor, in other words, relies too much on one at the expense of the other. There is too much greed (or fear), for example and not enough rational investigation (research). Alternatively, an investor may conduct too much research into a security and ignore his or her emotional quotient (gut instinct). Sometimes, an investor spends an extraordinary amount of time researching an investment and ignores that small voice that keeps reiterating, “This investment does not feel right!”

Following such emotional impulses may seem illogical, but often they are based on an observation about an investment that bothers the investor, yet the investor chooses to ignore the warnings. For example, an investor may be excited about a company’s prospects in cancer research and the potential discovery of a blockbuster drug, but the investor suppresses the fact that in the process of the company going public,1 insiders chose to reduce their stake in the company from 100 percent ownership of the shares outstanding to less than 5 percent ownership. In other words, corporate insiders are dumping their shares. If the prospects for this company are so good, why are the owners reducing their stakes so dramatically?

It is normal to uncover bad points about a company in the process of evaluating its prospects, but often a decision to invest in the stock of a company is made in light of the fact that, on balance, there are more good points than bad. Some bad points, however, are terminal. Hopefully, this book will make those bad points obvious.

The investor who spends too much time on research, however, and not enough time controlling emotion, is unusual. Usually, it is just the opposite. Most investors buy stock without any research whatsoever. This means that their motivation for buying stock is subject to the whims of emotion alone. As a result, there is no consistency in their purchasing behavior. Chance, rather than skill, is more dominant in determining whether or not an investment is profitable. Under such circumstances, rational judgment plays a minor role in the investment selection process.

Perhaps, for example, an investor listens to the comments of a guest on one of the many business talk programs on radio or television and immediately buys a stock without any further investigation. Alternatively, perhaps an investor buys a stock because the investor uses the product and reasons that any company producing such a good product (a subjective assessment) must be a good investment. Maybe an investor buys a stock because a company was the subject of cocktail party chatter or a favorable news release from company management about earnings. There are an unlimited number of reasons why investors buy (or sell) stock, but frequently, research into a company’s prospects is not one of them.

Investing is not about ego gratification. It is not a get-rich-quick scheme. The conclusion of one’s life is not measured solely by how many chips are accumulated, and accomplishment is not measured only by the size of the pot. When an investor assembles a portfolio for ego-gratification purposes, serious losses can result and the investor’s rate of return can decline.

The purpose of investing is to achieve financial goals, not soothe emotional needs. Investing is not a substitute for going shopping or gambling. When losses occur, and they will, the investor must be able to quickly recover emotionally and not dwell on losses. The investor needs to learn from the experience, evaluate what happened, and quickly put it in the past. Negativity,...