Investing Mistakes Part 1: Owning Your Most Valuable Asset by Andrew Hunt. Hunt is an Investment Manager and author of Better Value Investing: A Simple Guide to Improving Your Results as a Value Investor.
I like people admitting they were complete stupid horses’ asses. I know I’ll perform better if I rub my nose in my mistakes. This is a wonderful trick to learn. – Charlie Munger
“We all make mistakes” is something of a platitude when it comes to investing. But how many of us get the most out of our mistakes? And how much better could we be if we did? There is no such thing as a perfect strategy. All strategies open up the investor to certain risks. Great strategies define what they need to avoid doing as well as what they do. This is second-level thinking and this is where you can gain a real edge. Most investors intuitively focus on their past successes rather than their failures. Thus, they repeat the same mistakes over and over again.
I think it helps to view your mistakes as your most valuable asset. The likelihood is that you already know what you’re good at, and don’t need any encouragement to repeat it. Finding your flaws is what will help you improve. This is a quick guide to getting the most out of mistakes. In Part 2, I will go through what my biggest mistakes have been and what I’ve done about them.
- Accept you will make a lot of mistakes, some of which will seem really stupid
Over the past fifteen years of investing, I’ve grown my wealth at 28% per annum (after stripping out the effects of taxes, savings and withdrawals). Yet that record has been made with a hit-rate of just below two thirds – I’ve been wrong nearly 40% of the time! In three instances I’ve seen stocks go to zero. Moreover, some of the mistakes have been farcical. I once failed to notice the accounting currency was different from the exchange currency. Another time I omitted to spot a pension obligation larger than the market cap. No matter how good or bad your record, there is a lot to learn.
- Record every decision
The great advantage of recording every investment decision is that you cannot deceive yourself in the future. The truth is it is human nature to misremember things, and to reinterpret the past with a positive gloss. You don’t need to write a masterpiece; just the date, the price, the amounts, a few lines outlining the buy or sell case, and maybe a few relevant numbers or metrics. Some people also like to record their feelings at the time – such as, “I’m really not sure about this one…”or “This is a ten-bagger for sure!”
I prefer to do this in a handwritten notebook, but the exact format is a personal choice. The aim is to give an honest account of yourself.
- Define what you mean by a mistake
In order to identify your mistakes, you need to define precisely what a mistake is. You can define mistakes in different ways (e.g. your investment thesis doesn’t play out, doesn’t meet a required rate of return etc.). Personally I just define a mistake as whenever a loss in terms of total return is crystallized. This might seem an imperfect definition, but the advantage is that it is simple and objective to apply.
- For every mistake, complete an autopsy
When you make a mistake, acknowledge it and write it down. Then go over your work, and try to understand where you went wrong and what you can learn from it. If you can, get someone else to look over your analysis with you. A different perspective can be invaluable in identifying mistakes and weaknesses that you might have missed.
At the same time, accept that not every mistake will yield a simple answer. Sometimes your analysis will have been fine, but the investment just gets overtaken by an unfortunate yet unpredictable turn of events.
- Record your findings and talk openly about them
Once you’ve done your autopsy, write down what you’ve learned and talk openly about it. Discussing mistakes often leads to new insights. In an investment organization, talking openly about mistakes will strengthen the investment culture. It encourages others to share their own short-comings and take responsibility for them. Over time this fosters a culture of learning and mutual support, rather than a toxic and insidious blame culture.[i] It also keeps investors humble and honest. These qualities really matter in the long run.
- Use checklists to eradicate those mistakes in future
Having identified your mistake and discussed it openly, it is now time to make sure you don’t make that mistake again. I think the best way to do this is to build checklists that can be applied to future investment decisions.
When making checklists, keep them short, simple and objective. That way you are more likely to follow them when it matters most. And always be willing to evolve your checklists. Over time they should develop as you better understand your mistakes.
As far as I’m concerned, the simple checklist is the most valuable and underused tool available to investors. Checklists are most useful for taking out common errors.
- Learning from mistakes is about honing your investment process, not reinventing it
Over time, learning from mistakes should allow you to hone your investment process. Basically, the process becomes tighter and you become more discerning. You should not use difficult periods as a reason to capitulate and switch to the latest fad. Learning any particular style of investing – whether it be deep value, special sits, quality, income, growth or anything else – is a long journey that takes time and requires perseverance. It involves making lots of incremental improvements along the way. All those little improvements collectively make a big difference. Below is a passage from Anthony Bolton’s biography.[ii] It describes beautifully how the UK’s most successful institutional investor (6% annualised outperformance over 25 years!) used a difficult period to learn from mistakes and hone his process, while sticking firmly to his basic philosophy.
Despite his spectacular long term record, life has not always gone smoothly for Bolton as an investor. His biggest setback came in the 1990-91 recession, when his funds suddenly started to perform very badly. His run until then had been quite spectacular. In its first ten years, the Special Situations fund clocked up a cumulative return of more than 1,000%, a pace that was clearly unsustainable.
By the start of the 1990s however, a recession did hit both the UK economy and the financial markets hard. In 1990, the fund lost 28.8% of its value in a year. In 1991, the return was a positive one, but only just (3.0%). A number of Bolton’s holdings, instead of recovering from the economic downturn, as he had expected, simply went bust on him instead.
Bolton conceded later that this was his toughest period. In hindsight, the downturn of 1990-1991 can be seen for what it proved to be, namely an 18-month setback on the way to a renewed long run of future superior performance. At the time it was nothing like so obvious.
“I did a lot of soul searching in the early 1990s, when I had a bad patch... But the question was: should I change my approach or not? Thank goodness, I didn’t because that would have been the kiss of death. If you start doing a type of investment that you don’t feel confident in, that’s where you become completely unstuck.”
Since then, he and his colleagues at Fidelity have put a lot more effort into tracking ‘z scores’ and other tools used by credit analysts for spotting potential corporate failures...“It was the few where the finances were far worse than we realised that hurt us. We don’t want to make that mistake again. That is why we do a lot more balance sheet work now.”
But while he is open about the above average volatility of his funds, he has come to the conclusion that “I have an approach that delivers in the medium and longer term. Why mess it up because once in a while people have an uncomfortable period?” In any case, he says, good investment managers should not be over sensitive about their failures. Taking their lumps is part of the business. “You have to be comfortable in taking a different view from most other people. Most people like it if five people tell them they’re right – that makes them feel more confident. I am not a very emotional person, and I think that’s the only way you can run money. You’ve got to be very unemotional about stocks, and you have to be prepared to say you were wrong. This is the sort of business where you get bitten by the bug. It’s constantly changing, constantly challenging. You must change with the changing climate, and not fall in love with what worked last year or the year before. Just as importantly, you need the support of an employer who is prepared to ride over the lumpy periods.”
Andrew Hunt is a portfolio manager with one of the UK's leading investment managers. His new book, " Better Value Investing: A Simple Guide to Improving Your Results as a Value Investor." is available from Amazon.com and in good bookshops.
[i] https://www.researchaffiliates.com/Production%20content%20library/cfm.v25.n5.pdf [ii] Anthony Bolton & Jonathan Davis, Investing with Anthony Bolton (Harriman House, 2004)
