My greatest investing mistake

The best thing about writing of one’s investing mistakes, at least in my case, is the sheer richness and depth of the material. The hardest part is in knowing where to start.

After much forethought, I settled on a former Intelligent Investor Share Advisor resources analyst, Tom Elder, a tall, rangy man possessed of a clutch of whimsical stories and a farming brain pre-wired for value investing.

They say that past performance is no guide to future returns but, really, if not past performance, what should one use? Tom’s stock picking history was exceptional. Almost everything he recommended went up, and more often than not for the reasons he suggested it would.

Then along came a company called Croesus Mining. It was 2005 and two years had passed since Share Advisor had recommended a gold company. Asset prices were rising and the economy was ticking along just a little too well. A cheap, well-managed gold stock was just the ticket, offering protection against an economic slowdown with plenty of upside through a booming gold price if a recession ensued.

Going down

The story Cash crunch may help Croesus (Speculative Buy – $0.46), published on 30 March 2005, swung it for me. Even as I re-read it now, it’s hard to imagine how this company went under.

In December of that year Croesus came calling for cash at a time when its share price had fallen more than 40% since March. We recommended members subscribe to the rights offer, preceded by a few words that, in retrospect, were ominously pertinent:

‘This is a curious situation—the higher the gold price goes, the bigger the loss Croesus will report, even though its reserves are worth more than ever. That's because it is now forced to account for the profit it has forgone by locking in the price of some of its production in advance.’

In the end, it was the hedging contracts and declining production that brought the company undone. Croesus simply wasn’t producing enough to cover the cost of the hedging arrangements and the bankers pulled the pin.

On 16 Mar 2006 the company entered a trading halt from which it never emerged and almost every cent invested in the company, including the hundreds of thousands I had put in, was lost.

Nine years have lapsed since then, sufficient time to recover from the pain of the loss. Still, the clarity of my stupidity rings through the years. Public humiliation is perhaps my last shot at exculpation, so here goes.

A cataloguing of my foolishness inevitably begins with the psychological. Errors of the mind lead to mistakes in stock selection, portfolio allocation and subsequent trading decisions. These are merely the outputs. Almost every mistake begins in the brain – the organ that instructs the fingers to tap out the buy and sell orders.

Cognitive biases

Psychologists have described a series of cognitive biases that cover the variety of ways in which our thinking undermines our capacity for sensible decision making. In my Croesus experience, I submitted to many such biases.

I was impressed by Tom Elder, and rightly so. A resources analyst with intimate and personal knowledge of the industry, he had worked hard to overcome his own biases. His humility and capacity for doubt impressed so much that the more Tom reaffirmed it, the less likely I thought he might actually be wrong. Yeah I know, weird.

Psychologists call this the Halo Effect, a tendency to admire all of someone’s decisions, based on a few favourable personality traits.

It’s in the nature of stockpicking to get calls wrong, but the less that happens, the more investors are inclined to believe that it won’t, that they’ve found someone with ‘the golden touch’. Hero worship, such as the almost messianic adoration of Warren Buffett, blinds us to the possibility of human error, and there’s nothing like a great track record to seal the deal.

Chalk up mistake #1. Every investment must be judged on its merits, not on the personality of the person making the case for it.

My own ego also played a part. I’d just sold a large part of my shareholding in Intelligent Investor and had more money than at any other time in my life. I was in many people’s eyes, especially my own, a success.

That primed me for the hot-hand fallacy, the mistaken belief that a person that has experienced success once is more likely to do so again. Perhaps that’s why I allocated 30% of my portfolio to a speculative gold stock at a time when I wasn’t gainfully employed, had no plans to work for another few years, had three young children under five and a serious health problem. Go figure.

Allocation error

Whilst mistake #2 was technical, a portfolio allocation error of giant proportions, its genesis was entirely psychological. Our maximum portfolio weightings are an inbuilt speed limiter on a galloping ego. Adhering to them will prevent you from making the mistake I made in 2005.

Of course, we all re-evaluate our decisions after taking them, before inevitably reverting to our original position. In my more lucid moments I did wonder whether I had allocated too much to Croesus but then confirmation bias took over.

In Top stocks for three years, published on 7 Dec 05, former research director Greg Hoffman and another analyst nominated Croesus as one of their three picks. Could they be wrong as well as Tom Elder and I? I doubted it. The hive mind was alive and well and I was making my third mistake without even knowing it.

Because people’s livelihoods are at stake, making stock recommendations is a serious business so the process around which we make them requires constant refinement. Introduced in 2009, the Dragon’s Den is a forum for every analytical assumption to be challenged and every possible contrary argument mounted.

Nature has a way of correcting for the three classic errors I made. It’s called failure, which is what Croesus and my investment in it became.

But perhaps the greatest and potentially more costly mistake is to resist the evolutionary impulse to improve ourselves by reflecting on our experiences, to instead wallow in the psychological pain of loss and take nothing from it.

Research changes

The changes we’ve made to our research processes at Share Advisor,and the way we present our recommendations to you, demonstrate a capacity for organisation-wide learning. And our portfolio performance and recommendations report suggest these have had a beneficial impact on the returns you make from our stock recommendations.

As for me, I like to think I have learnt from a painful experience but if not, at least you may have gleaned something valuable from my telling of the tale.

At the very least, I do know I have overcome loss aversion bias. In 2008 Croesus emerged from bankruptcy with my shares being worth less than $500. The company made a compulsory purchase and I considered the matter closed after I banked a cheque for a few hundred bucks.

Then I read this story. Croesus had become Sirius Resources and by March 2013 was up 8,600% on the year. Even my paltry shareholding of a few hundred bucks would have been worth tens of thousands had I hung on. But if that’s the price of a good story, so be it.