My first mistake: investing in bulk Scrabble tiles.
This post is difficult to write — I’ve been putting it off. It’s embarrassing to talk about mistakes I’ve made that have lost me 20%, 50%, or 100% of my principal. But I feel a sense of responsibility to share the gory details of my own foolish, greedy, and sometimes reckless attempts to grow money.
Here’s what I hope to accomplish by writing this post:
- better understand the nature of these mistakes, so I don’t make them again in the future
- help at least a few of my readers avoid making these same mistakes themselves
- provide a little inspiration to younger people who are just starting off their careers and investment plans
I’ve been fascinated by investing since the day I learned at a young age that a bank would give you money (interest) for your deposits.
Since then I’ve made a some good financial decisions and some bad ones. The bad ones mostly all fall into the “classic” mistakes that inexperienced investors make, though a few of my mistakes required ingenuity and above-average foolhardiness.
Without further ado here’s my list of “greatest hits” investment mistakes, for your edification and entertainment. Maybe you can avoid some of the traps I waltzed into!
Mistake #1: High Risk, Low Reward Business Ventures
Back in the late nineties I was a party promoter in San Francisco, organizing dance music events with my crew. Qoöl at 111 Minna (which we happen to be relaunching as a monthly next week) was our most successful event, running as a weekly for fifteen years, often with a line out the door. But we also threw some real stinkers — expensive events that were attended by almost nobody.
Planning for one particular event, one of our DJ co-promoters came up with an idea for a promotional flyer so audacious and elaborate that it would require six kinds of ink (including a metallic silver) and a custom die cut to produce. In addition to the expensive flyer, the venue wanted a bar guarantee (our patrons would order a minimum amount of alcoholic beverages, or we would pay the difference to the venue).
When we ran various profit/loss projections for the event we quickly realized that we would only make money under the most optimistic, best-case scenario. Even breaking even would be a stretch.
Still, I signed off on production, believing the “no risk, no reward” mantra. While this is technically true — it’s hard to make money without taking any risk at all — the ideal approach is to minimize risk while maximizing potential rewards. This business venture did the opposite. We stood to make only a little money even if everything went great, but the potential downside was quite large.
Predictably, the event was not well attended. Despite our luxurious flyer (which came out beautifully — I still have one somewhere), our regular crowd treated the new venue like the plague (it was not a popular club at the time). This disappointment was followed by a dispute with the venue regarding the bar guarantee amount (which nobody bothered to put down in writing).
At the time, the loss stung. We (myself and my business partner) invested about half of our business savings into the event, and lost all of it.
The upside was learning to minimize risk. Never again did we ignore the potential downside when planning an event or product or service. This idea — setting affordable loss — is a key principle of the effectuation system (which I plan to discuss in more detail in a future approach — it’s my current approach for all business ventures).
This mistake is particularly common among people who come into large amounts of money. Professional athletes are notorious for making high risk, low potential reward investments (investing in new restaurants, independent films, or ill-conceived start-ups).
In hindsight this one could have been a lot worse. All the friendships involved survived (even to this day) and the lesson was invaluable.
Mistake #2: “Fake” Diversification
Through the 90’s I did pretty well financially, saving money and regularly investing in mutual funds (I had internalized the “a part of all you earn is yours to keep” line from The Richest Man in Babylon). Of course I was getting dinged by high mutual fund fees, but the stock market was going up and I did better than I would have if I stayed in cash.
After the stock market crash of 2000 I realized that I needed to start allocating my assets into different “buckets” to provide more protection against volatility. No problem. Over the course of a year or so I diversified into various emerging market ETFs, the SPY ETF which tracks the S&P 500, a popular small-cap ETF, and even some gold coins.
I was now feeling pretty smug. I was paying much lower fees than when I had owned mutual funds, and my allocation strategy would protect me against market volatility. I was only in my mid-thirties, so I wasn’t worried about not owning any bonds.
So do you think I was protected during the 2008 crash? Ha!
What I quickly learned was that “diversification” within equities is pretty much meaningless. When U.S. stocks go down, so do all stocks, globally.
Over the course of a year my portfolio value was cut in half. I did well with the gold (and also buying house in Oakland, which happened around the same time), but otherwise I was way down.
Despite the pain, I had the sense not to sell. I even bought more SPY on the way down, which ultimately turned out to be a good decision. But I was shaken so badly, it led to my next biggest mistake (mistake #5 below).
The takeaway is that diversification needs to be across asset classes (stocks, bonds, real estate, commodities, gold, cash, etc.) and not simply within a single class. I knew this before the crash of 2008, but I didn’t follow the advice (except for buying a house — but that was because we needed a place to live and at the time it was cheaper than renting; I never thought of the house purchase as an investment). I was greedy, putting almost all of my money into the asset class that I thought would make the most gains, and vastly overestimating my emotional ability to tolerate loss. As it turned out, it wasn’t the loss itself that hurt me — the stock market eventually came back. It was getting shaken by the loss that really hurt me, because it prevented me from investing on a regular basis.
I’ll explain why this was my biggest mistake, but first I’ll go over two “sidebar” mistakes that highlight my youthful hubris.
Mistake #3: Smart People Don’t Make Smart Financial Decisions
In the mid-2000’s I had the brilliant idea of starting an investment group. I would invite the smartest people I knew, and with our combined brainpower we would beat the stock market and all become millionaires.
Well, it started off pretty well. We drank wine, ate cheese, and planned our financial conquest. We called ourselves the “Bling Trade Collective” and even made it official with a partnership agreement and a joint investment account. Everyone contributed a couple grand and we were off.
The first thing I learned is that getting a bunch of smart people to do anything is like herding cats. Everyone had a strongly held opinion, and they were all different. We had a well-defined investment philosophy to guide our decisions. In fact, we had twelve of them: one for each group member.
Our general format was that one person would research a stock, present their findings to the group, and then we would all discuss the pros and cons of investing in the company, and then invest (or not). Of all the group members I was the best at presenting and convincing the group to buy the stocks I suggested (I guess that Rhetoric degree came in handy). Unfortunately the companies I suggested usually depreciated 50% or more in value soon after we bought in. Our bottom line was saved by the three women in the group who managed to pick only winners.
Ultimately enthusiasm in the group flagged — we weren’t making money and we never managed to agree on a single coherent investment strategy. Attendance dropped off, we sold everything, and the cash languished in our joint account. This inertia (not our collective smartness) saved us during the 2008 crash — we were almost entirely divested by that point. I got tired of filing the tax forms and we closed the group, returning everyone pretty much the exact amount of their initial investment.
I don’t regret starting Bling Trade Collective. We had a great time, new friendships were formed, and many of us remain friends to this day. I learned that specialized knowledge trumps general intelligence, at least when it comes to playing the stock market.
Mistake #4: Just Invest Like Warren Buffett
Soon after the demise of Bling Trade Collective, I reworked my own investment strategy. My new idea was to just copy what Warren Buffett did. After all, he is one of the most successful investors of all time, and his investment strategy is not a secret.
What I soon learned is that to invest like Warren Buffett, you need to put in a great deal of time into researching public companies. One of the first things Buffett does when researching a company is look at the last ten years of ROE (return on earnings). This kind of information isn’t that easy to get. Yes, it’s public, but it’s not the kind of thing you can plug into a spreadsheet algorithm and instantaneously pull from an internet database (like you can with stock price, or even the last reported price-to-earnings ratio).
Even when I was able to find the information that Buffett usually collects, I didn’t fully understand it. One of the most basic skills you need as a value investor is the ability to read a balance sheet. I don’t have this skill (at least not on any kind of sophisticated level).
Often I would spend half a day or even a full day researching a company in the Warren Buffett style, and 95% of the time decide not to buy. This just wasn’t a cost effective investment method — there was a huge opportunity cost in terms of time sink. I could be using that time to earn money doing consulting work, write music, or do things more fun that look at balance sheets. I can only assume that Warren Buffett loves to read balance sheets. I don’t. I’m not Warren Buffet, nor should I try to be.
There are ways to get good returns over time, with minimum risk, while only spending a few hours a month managing your investments. Many aspects of your investment system can be automated. I’ll go into more details in a follow-up post, but my main takeaway from this mistake was that I didn’t want to spend a lot of time researching company fundamentals. Even if I could find good deals that way and make potentially make a good return in the long-run, I didn’t enjoy the process.
Mistake #5: Staying on the Sidelines/Not Investing Regularly
After the 2008 crash I held steady, bought in a little more, and then pretty much ignored the stock market for the next seven years. This seven year period happened to coincide with one of the largest bull markets in history! Because I was disillusioned with investing, I missed out big.
I didn’t have much cash to invest after 2008 — I was very heavy in stocks. Over the next seven years I earned well and saved over 15% of my income. While I did regularly transfer money into my regular IRA and Roth IRA, I didn’t buy anything during that time, not stocks, not bonds, not gold … nothing. Everything looked like it was priced too high, and I was spooked. I also felt disillusioned regarding investing in individual stocks; I had blown too much time in my attempts to emulate Warren Buffet, and I just didn’t want to deal.
When I was in my thirties I could keep cash in a high interest savings account and it would grow with a 5-10% interest rate. Crazy times! But as you know, interest rates in savings accounts and money markets are all less than .05% these days, and have been this low for years. While I still held many of my older investments, my new hard-earned savings were doing a whole lot of nothing. I realized that I was never going to reach my savings goals if my money wasn’t growing at all, but the higher the stock market rose, the more nervous I became about investing.
I’ll explain what I ended up doing in a later post, but for now I’ll just say that I missed a huge opportunity. I should have been investing on a monthly basis according to a predefined allocation strategy across multiple asset classes. I would have ended up with much better returns.
I don’t feel sorry for myself — I’m probably better off than 90% of people in the world, and like most U.S. citizens I live in a completely different universe than people who subsist on $1-2/day. But it is important for me to share these mistakes, to help others (working class, middle class, or rich) formulate and stick to an intelligent savings and investment plan. It’s the only way to hold your own against the ultrarich who inherit huge sums of money, use sophisticated tools, and play by different rules.
Anyone can grow a sizeable nest egg — even if you only earn minimum wage. The key is coming up with an intelligent system and sticking to it.
Mistake #6: Selling
Rebalancing is one thing — it makes sense to rebalance your portfolio when your percentages get out of whack. But more and more I’m thinking that if you don’t think it’s a good idea to hold a company forever, it’s probably not a good idea to buy it in the first place.
I’ve tried momentum trading, and while I’ve gotten lucky, I’ve also been burned. Worst of all, when I made money, I made far less money than I would have had I just bought and held.
I bought AAPL at 20, sold at 30. Good deal, right? If I’d held, I would have increased my initial investment forty times (remember that Apple did a 7-1 reverse split in 2014). Ouch. That’s a house down-payment I left on the table, just from one trade.
Mistake #7: Trying to Short the Market
Around 2010 there was a wave of panic as various Euro-member countries got into financial trouble. Many experts were predicting a giant market crash (many of the same experts who had been correct about the 2008 crash). I didn’t want to get out of the market entirely, but I wanted to reduce my risk exposure. I invested a significant amount of money in an EFT (VXX) that I thought would provide a hedge against a broad decline in equities.
The problem? VXX only provides a short-term hedge. Because of the way the fund is structured, it’s almost guaranteed to go down in the long run.
I lost thousands of dollars with this attempted hedge. The lesson? Don’t invest in financial instruments that I don’t fully understand!
Mistake #8: Currency Trading Idiocy
Soon after the VXX debacle I had another clever idea. Searching for any kind of interest rate, I noticed that one of my banks was offering foreign currency CDs, some with rates that looked pretty good. However I didn’t want to buy a foreign currency that was an all time high against the U.S. dollar. I wanted to buy-low, sell-high, not the opposite!
I did my due diligence, researching the historical relationship between the U.S. dollar and the New Zealand dollar (USDNZD=X). The New Zealand dollar looked like a good deal — it was at a historical low vs. the U.S. dollar! I bought the CD and patted myself on the back.
Only one problem: I should have been looking at NZDUSD=X … I’d reversed the charts! The New Zealand dollar was actually close to an all-time high vs. the dollar at the time. Oops. No wonder they were offering such an attractive interest rate. The U.S. promptly rose, greatly devaluing my investment in NZ dollars.
Lesson: spend an extra couple minutes making sure the chart means what I think it means.
But I’ve Done a Few Things Right …
I could go on. Really, I could! But it would be too embarrassing.
Despite all these mistakes, I’m doing pretty well these days. I’ve made a few good financial decisions too. For example:
- I accumulate as little debt as possible and pay it off quickly.
- I live well below my means.
- I married well (when I met my wife she was working as a waitress in a cocktail bar, but now she runs a thriving business and currently earns more than I do).
- I maximize the amount of pleasure I can get from small luxuries (and skip most of the big ones, thus saving money).
- I save at least 15% of what I earn.
- I keep investing and trying to come up with a good slow-growth system (despite previous mistakes I stay in the game).
- I have learned skills that allow me to charge a high rate for my time.
- I have created businesses and intellectual property that generate passive income (music royalties).
- I’ve developed an investment system that takes very little time to manage, protects against market volatility, and will (hopefully) generate the slow compounded returns I need to meet my/our ultimate “nest egg” goal (an amount big enough to generate investment income to support my family’s lifestyle preferences, without using the principle). I can take you through the steps to do the same, provided you’re willing to put aside at least a few dollars a day for investment purposes.
I don’t “have it all figured out” but I will share the details of my personal investment system in a future post.
I hope you enjoyed reading about my history of investment mistakes, missteps, and foolishness!