“I’m only rich because I know when I’m wrong. I basically have survived by recognizing my mistakes.” – George Soros
One of the best and worst things about the financial markets is that they’re never going to be perfect. There will always be something to worry about because even stability can breed instability. This is one of the many things that makes the markets so challenging.
For this and a number of other reasons (mainly because we’re all human), you are bound to be wrong over and over again in the markets. Being wrong comes with the territory. To make matters worse, a lot of the time you can make perfectly rational decisions and still end up losing money. Let me count the ways…
You can pick the right stock but in the wrong industry.
You can pick the right asset class but in the wrong geography.
You can pick the right country but in the wrong currency.
You can nail the direction of a trade but not the timing.
You can time things perfectly but invest in the wrong stocks.
You can invest in the right market but in the wrong style of stocks.
You can nail the macro but miss the micro implications.
You can optimize your asset allocation based on past experiences but be blindsided by new risks in the future.
You can nail the earnings expectations for a company but underestimate how much of that was already baked into the share price.
You can know a company inside and out and put in hours of research and still be blindsided by an unexpected piece of news.
You can get the news right but not the reaction of the markets.
You can short a terrible company that receives a buyout offer.
You can buy a cheap stock/market that continues to get cheaper.
You can bet against a terrible business that gets the seal of approval from Oprah.
You could invest in a strategy that outperformed in the past but badly underperforms in the future.
You can invest based on a high probability investment opportunity that sees a low probability outcome.
You can sell a stock/market that’s gone up but watch it just keep rising.
You can buy a stock/market that’s gone down but hasn’t gone up in value.
You could pass up a quality investment opportunity because “it’s had a huge run” or “has more room to fall” or “the easy money has been made.”
You can try too hard to be right all the time.
The thing is, these are all honest mistakes. I didn’t even delve into the realm of unforced errors caused by our behavioral biases and general human nature. I think that’s where so many investors get into trouble. It’s hard enough to have a good batting average with a solid, well-thought-out investment process. Even the best investors are sure to be wrong. You need a humble attitude to survive in the markets. Those who try too hard to be right about every single investment thesis and tiny market wiggle are usually the ones who make the most mistakes by trying to be too precise with their analysis and decisions.
Investors can’t expect to be right at all times. You’re going to be wrong on occasion even when you make the right decisions. Understanding that poor outcomes can happen to a legitimate investment process is a huge step in becoming a better investor. The thing is you can poke holes in any investment strategy out there. The trick is finding the one with flaws that you’re comfortable with.
Many, many years ago when I started out as a stock broker, I hadn’t been in training in three days when I was told by my trainer the truest thing I have ever heard about investing: “you’ll never ever become intelligent in this business until you realise you know nothing”.
Good one. And one that most people never hear right out of the gate. My experience has been that most young people come in thinking they know everything and it takes them time to figure out that the more they learn the less they really know.
Socrates and/or his student Plato said:
“I know that I know nothing”
In Hellenic (ie. Greek):
Εν οίδα ότι ουδέν οίδα
“Diversification is protection against ignorance.” – Warren Buffett
Warren Buffett is correct. But don’t let this statement trick you. Diversification is crucial for investors.
There is no doubt diversification is a hedge for ignorance… but no one is omniscient. Top managers and insiders don’t always know what’s happening in their businesses. Seemingly great businesses can go bankrupt quickly. Remember WorldCom, Enron and GM?… just to name a few.