Even the world’s best investors mess up. Back in the 1990s, Warren Buffett bought a small Maine footwear business called Dexter Shoes. Not only did it go out of business, but Buffett had purchased the company with Berkshire Hathaway stock instead of cash. Those Berkshire shares today would be worth over $16 billion.
This year’s volatile financial markets, beset by uncertainties over geopolitics, inflation and a slowing economy, can easily trip up investors. Bottom Line Personal went to four of our top investment professionals and asked them to reveal their most memorable investment blunders—and the lessons they learned from them…
Mistake: I sold a winning stock too soon—and missed out on 500% worth of gains! I invested in the interactive videogame software company Electronic Arts (EA) back in the early 2010s. EA had created best-selling games such as The Sims, FIFA Soccer and Madden NFL, but the company’s profits were flatlining because store sales of boxed games were declining. This was the smartphone’s early days, so my investment thinking was that digital downloads of games would rapidly gain popularity and boost EA’s profit margins for years. Plus, the smartphone would open a whole new market for adult videogame players, rather than just kids on their gaming consoles. I bought EA at $16 per share. The stock turned out to be hypervolatile. For eight months, the price declined almost every day…then the share price doubled…and doubled again! By then, I was just psychologically exhausted, so I took a decent profit and dumped my entire stake. Over the next few years, I watched from the sidelines as EA’s earnings continued to explode to the upside just as I predicted. Today, EA stock sells for about $140 per share.
Lesson learned: Investing is a mental game. You can do great research and analysis and get all the intellectual work correct. But it won’t matter if you can’t ride out the rollercoaster of owning a stock and control your emotions. I now find it useful to focus on how my entire portfolio is doing, rather than obsess over the daily fluctuations of each individual stock. I also can dramatically minimize the impact my emotions have by picking areas of the market where I know I can remain rational and avoiding those where I can’t.
Vitaliy Katsenelson, CFA, is CEO and CIO of Investment Management Associates, which manages about $300 million in assets, Greenville, Colorado. He is author of Active Value Investing and The Little Book of Sideways Markets. IMAUSA.com
Mistake: I fell under the spell of a legendary mutual fund manager. Back in the 1990s and early 2000s, there was no more celebrated investor than Bill Miller, manager of the Legg Mason Value Trust Fund. His eclectic portfolio mixed beaten-down financials and undervalued industrials with young, fast-growing tech stocks. Miller’s annual performance beat the S&P 500 for 15 consecutive years and nearly doubled the cumulative returns of the index over that period. While most fund managers wrote dry and uninformative quarterly updates to shareholders, Miller’s were fascinating and drew on his PhD studies in philosophy. Between adding investment money to Miller’s fund and its continual growth, it eventually dwarfed every other holding in my portfolio. I just didn’t see the rationale behind selling shares in the fund and moving my money to less successful funds even though the Legg Mason Fund had swelled to nearly $20 billion dollars and held an aggressive portfolio of just 40 to 50 stocks. Then during the 2007-09 financial crisis, it all came crashing down. I watched in horror as Legg Mason Value Trust fell nearly 75%, due in large part to its overweight financials. The fund was never the same. Miller took on a co-manager, instituted a slew of risk controls and produced very ordinary performance until he stepped down three years later.
Lesson learned: It’s easy to give lip service to the concept of diversification—but it takes effort and diligence to actually practice it. Any area of the stock market can outperform for sustained periods (large-cap US tech stocks come to mind now), but when momentum shifts, it can happen shockingly fast and wipe out years of outperformance. Diversification doesn’t just mean owning a bunch of mutual funds. It also means getting exposure to a broad sampling of asset classes, investment styles and sectors. If you find it difficult to regularly trim areas of the portfolio that are overweighted relative to your investment policy and use the gains to add to lagging funds, set up automatic rules for rebalancing that you follow…no matter what. My experience with Bill Miller hasn’t made me abandon talented active managers, but I am more cognizant of their risks and downsides. Now, I prefer to mix low-cost index funds with active management in particular areas, such as small-cap stocks, where there is a better chance of outperforming.
Josh Charlson, CFA, is a director of manager selection for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc., Chicago. Morningstar.com
Lesson learned: Never allow a small loss to become a very large one. Only invest what you are willing to lose. Simple math makes it very difficult to ever recover from a big loss. A 20% drop requires a stock to gain 25% to get back to even. A 50% loss requires a 100% gain. Better: Set a limit for when to automatically cut your losses. Many professional investors sell at 7% to 8% below their purchase price. To avoid the loss-aversion bias…
Another lesson: Have an accountability partner. I loved my Peloton bike so much that I confused my personal experience using the product with the financial potential of the company and industry. Select someone you trust to run investment ideas by, even if it’s just a friend or family member. One interesting resource: I’ve started using the mobile phone app RAFA. It’s an interactive artificial-intelligence (AI) investing copilot, built by a team of former Nvidia engineers, that can analyze billions of data points in financial markets. I present my investment ideas and personal objectives to RAFA (Rafa.AI) and ask for pros and cons. Cost: Available with a free 14-day trial, then $29.99/month.
Brian Bonewitz, CFA, is a consultant based in Charlotte, North Carolina, specializing in AI-driven investment solutions that enhance financial agency. Previously, he was a portfolio manager and equity analyst at a Registered Investment Advisory firm with over $3.3 billion in assets under management.
Mistake: I discovered a stock that looked like a big winner on paper—but it was all an accounting fraud. Early in my career, I invested in a financial-services company on the New York Stock Exchange. Mercury Finance had been spun off from the regional bank First Illinois and specialized in subprime auto lending. I kept checking the company’s balance sheet and income statement over and over, and the numbers were very compelling. Mercury was growing quickly with hundreds of loan offices around the country. The profit margins in this type of lending are huge and can be worth the risks. Upshot: The stock market must have sensed something I didn’t. Mercury Finance was a massive fraud. The company had manipulated earnings, failed to charge off unprofitable loans and reported a profit of $120 million one year when it had actually lost $30 million. The stock imploded…shareholders lost $2 billion…and the CEO was sentenced to 10 years in prison.
Lesson learned: No matter how meticulous and confident you are in researching a stock, there are risks beyond your control. Overconfidence is a big reason small investors underperform the stock market. Accept that financial markets are pretty efficient and often smarter than you are. If you find a sure thing, ask yourself why no one else has your insight. Also, stick to a disciplined investment plan. Make small bets at the margins of your portfolio. That way, if you are wrong, your losses are minimized. But if you are right and the stock soars, you profit handsomely.
Bruce Kaser, CFA, is president and CIO of Rohenth Capital Research, Lexington, Massachusetts. Previously, he was a senior portfolio manager with RBC Global Asset Management, where he co-managed more than $1 billion. RohenthCapitalResearch.com
