We’re always wrong. No matter what amount of analysis we do, what level of due diligence we engage in, we are always wrong in some aspect of our vision of what is going to happen. This is a hard and fast fact. It doesn’t matter if it’s the macro view we’re looking at, or if it’s trying to figure out a small company selling produce to Mongolians (more on that later…). It’s why arrogance deserves no place in an investor’s psyche.
Don’t get me wrong, I’ve made a lot of money investing over the years. Managing my personal money is my livelihood, so there have certainly been more profitable calls than unprofitable ones, however I believe the single biggest reason for this success lies in an acknowledgment of always being a “little” wrong.
George Soros and The Alchemy of Finance
I credit this thinking to George Soros who is clearly a better trader than a writer (unless you love psychology, markets and history like me you’ll likely find his books as tasty as chewing on your mouse-pad). He discusses the psychology of this in his book, The Alchemy of Finance.
One of the many takeaways from the book is to seek out the risks and determine exactly what they are, to in fact delight in finding your flaws. This is the polar opposite of what most investors do incidentally. Most investors take a position and then seek justification for the positions while actively shying away from viewpoints that are contrary to the position they have taken. It’s better to seek out the risks and determine what portion of your investment thesis is wrong, or potentially wrong, given a certain set of outcomes. This allows you to be cognizant of risks arising and not getting blindsided by events that you hadn’t accounted for.
Importantly this new-found knowledge doesn’t mean that you would necessarily sell a position but merely keep an eye out for dangers that have been identified. There are always risks, as investors and traders we simply wish to be aware of them so as to rationally quantify them and make decisions accordingly.
In mid-2006 I liquidated all my real estate holdings in New Zealand, except those for personal use, which I don’t consider an asset. I had been investing very aggressively from late 2002, but by 2005 I was finding that my inability to identify real estate deals that made it past even the most cursory test was growing exponentially. It was difficult to find anyone who valued real estate by any sane metric, such as replacement costs or rental yields. The only consideration seemed to be whether next months’ credit card bill could be paid, and paying said credit card out of home equity didn’t seem to be something that was frowned upon, but more an indication of how easy this entire “getting rich” lark really was.
Properties Max Out and Turn South
Geniuses were springing up all over the place. Pareto’s law was wrong. Everyone could get rich and not just the 20%.
Did I know that property was destined to top out and turn south?
Well the signs were definitely there, but nobody knew WHEN this would take place. It didn’t matter though as all that was required to be considered was that the risk/reward profile had gotten seriously out of whack. The risks in the market I had identified prior to buying into the market were now rising at an astonishing rate and screaming for my attention on a daily basis. There were fellow investors who had done very well indeed in the market but refused to see the rising problems. Instead of delighting in being able to get out ahead they continued investing. I know some who lost everything and others who are in very difficult situations now with balance sheets that have literally imploded. (and we haven’t even dealt with the problems I alluded to when discussing Australian and NZ real estate).
Markets can and do often get more out of whack than one can ever imagine, and when you’re involved in the game with your own hard-earned capital on the line, and not just a spectator to the goings-on, it’s simply not a smart move to play with fire. This is why it is always a better feeling to be out of a market which continues to rocket higher based on nothing but the greater fool theory. This is especially true when investing in illiquid stuff like real estate, where a trailing stop doesn’t exist.
What Helped Me Avoid Dangerous Investments
As a good friend of mine commented recently when describing me, “A patient and calm sense of paranoia.” Still not sure if that’s a compliment or not. What I do know is that being alert to risks and acknowledging that you’re wrong, always wrong… somewhere, and searching for that piece of the puzzle has helped me avoid dangerous investments and enabled me to get out of others without substantial losses, which I should never have gotten into in the first instance. Ironically it makes me less stressed.
There’s little point in worrying about things that are going to happen which we can’t control. I’m going to die, life on planet earth will cease to exist, and I’m presently wrong somewhere with one or more of my investments. These are all irrefutable facts. One of them however I have the power to affect the outcome. That’s the one I’m intent on examining – looking for my flaws.
The 1 easy step to becoming a better investor that has worked for me is to realize that what we think we know may be wrong, and what we do not know is always knowable, and to be ever vigilant of this. Let me make the point that vigilance is not stress. Stress is what you get when you are blindsided after having your head in the sand. Stress is what you get AFTER failing to realise your flaws when your net worth takes a hammering when you lose your house, your business and your relationships suffer. This is very very real and painful. Sometimes it builds character in people but more often than not it destroys them, emotionally, financially and physically.
Searching for my flaws has worked wonders for me. I’m curious to know what actions readers have found useful. Let us know below.
“I’m only rich because I know when I’m wrong.” – George Soros