Philip Fisher: How To Avoid One Of The Biggest Mistakes Made By Investors

One of the best books ever written on investing is Common Stocks and Uncommon Profits, by Philip Fisher. The book is a must read for all investors. There is one passage in the book in which Fisher discusses one of the biggest mistakes made by investors due to their ego, and how it can be avoided.

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Here’s an excerpt from the book:

Two of the important characteristics of common stock investment are the large profits that can come with proper handling, and the high degree of skill, knowledge, and judgment required for such proper handling. Since the process of obtaining these almost fantastic profits is so complex, it is not surprising that a certain percentage of errors in purchasing are sure to occur. Fortunately the long-range profits from really good common stocks should more than balance the losses from a normal percentage of such mistakes. They should leave a tremendous margin of gain as well.

This is particularly true if the mistake is recognized quickly. When this happens, losses, if any, should be far smaller than if the stock bought in error had been held for a long period of time. Even more important, the funds tied up in the undesirable situation are freed to be used for something else which, if properly selected, should produce substantial gains.

However, there is a complicating factor that makes the handling of investment mistakes more difficult. This is the ego in each of us. None of us likes to admit to himself that he has been wrong. If we have made a mistake in buying a stock but can sell the stock at a small profit, we have somehow lost any sense of having been foolish. On the other hand, if we sell at a small loss we are quite unhappy about the whole matter.

This reaction, while completely natural and normal, is probably one of the most dangerous in which we can indulge ourselves in the entire investment process. More money has probably been lost by investors holding a stock they really did not want until they could “at least come out even” than from any other single reason. If to these actual losses are added the profits that might have been made through the proper reinvestment of these funds if such reinvestment had been made when the mistake was first realized, the cost of self-indulgence becomes truly tremendous.

Furthermore this dislike of taking a loss, even a small loss, is just as illogical as it is natural. If the real object of common stock investment is the making of a gain of a great many hundreds per cent over a period of years, the difference between, say, a 20 per cent loss or a 5 per cent profit becomes a comparatively insignificant matter. What matters is not whether a loss occasionally occurs. What does matter is whether worthwhile profits so often fail to materialize that the skill of the investor or his advisor in handling investments must be questioned.

While losses should never cause strong self—disgust or emotional upset, neither should they be passed over lightly. They should always be reviewed with care so that a lesson is learned from each of them. If the particular elements which caused a misjudgment on a common stock purchase are thoroughly understood, it is unlikely that another poor purchase will be made through misjudging the same investment factors.

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Article by Johnny Hopkins, The Acquirer's Multiple