Why Most Investors Fail in the Stock Market
Throughout the past 30 days of wild volatility, here’s what I didn’t do.
Panic.
Worry.
Sell.
In fact, the best I did was add to a couple of positions yesterday.
The world was already in an uncertain state for the past 3+ years. It’s just that with the market rising, we pushed the issue to the back of our mind and ignored it.
If you read Howard Marks latest memo, On the Couch, he explains the problems and the psychology side better than I ever could. (Go read it)
But here’s a quick summary of how to succeed in this market, and why most people fail.
In order to be successful, an investor has to understand not just finance, accounting and economics, but also psychology. – Howard Marks
Lack of self-control emotionally is why most people lose money in the stock market, but I add other aspects in this article.
People who have failed will often try to blame the market when in reality, most investment failures fall squarely on the investor.
What I’m writing here is nothing new. It’s obvious.
It’s so obvious and familiar that it’s dangerous.
Familiarity is dangerous.
Say you go to a friends home who lives close to the airport. A plane flies by and the sound of the jets are numbing.
Yet your friend doesn’t notice.
“Didn’t you hear that?” you ask.
“Hear what?” he replies.
That’s what familiarity does to you if you aren’t keeping up with people like Howard Marks who pokes at you in the right way.
You don’t notice your bad habits and the obvious signs that you’ll lose money.
People Fail Due to Greed and Speed
It all seems so obvious: investors rarely maintain objective, rational, neutral and stable positions. First they exhibit high levels of optimism, greed, risk tolerance and credulousness, and their resulting behavior causes asset prices to price, potential returns to fall and risk to increase. But then, for some reason – perhaps the arrival of a tipping point – they switch to pessimism, fear, risk aversion and skepticism, and this causes asset prices to fall, prospective returns to risk and risk to decrease. – Howard Marks
People whose vision is clouded by seeing dollar signs and want to make a lot of money fast are setting themselves up for disappointment and failure.
Sure, they may get lucky here and there, but the combination of greed and speed is the complete opposite of the Old School Value approach where you use a methodical approach and take a long haul approach.
One of the advantages you hold over the professionals is to do the opposite of what the pros and traders do.
If they want to play the millisecond trade game, then go for monthly or yearly trades.
Don’t play by their rules because you’ll only lose.
Use time to your advantage.
Use their greed and fear to your advantage by simply sitting out until valuations make sense.
People Fail Due to Overconfidence
This one is truly a sleeper because who introduces themselves as overconfident?
It’s perfectly fine to think of yourself as confident, but who labels themselves as overconfident?
But when you look at results from a variety of industries and across different fields, it’s embedded and hidden everywhere.
94% of college professors believe they are great teachers.
I probably only met 10% of them.
Majority of drivers believe they are great drivers.
So why do accidents happen?
In a survey of 300 investment managers, 74% believe they were delivering above average performance.
But more than 74% of funds underperform the market.
His accuracy rate of picking winners was only 46% and his colleagues couldn’t figure out how he could be doing so well.
The secret?
This particular person knew that accuracy and being an egotistic stock picker was meaningless to his goal of generating high returns. His colleagues focused on picking “winners”, trading in and out of positions to lock in measly gains to look good on paper.
This analyst focused on cutting losses on mistakes quickly and held onto his winners with conviction and added when necessary.
Be confident – not that you’re a better investor, but be confident in knowing your weaknesses.
Be confident in your willingness to admit mistakes.
Be confident in your ability to prevent mistakes.
True wisdom is knowing what you don’t know. – Confucius.
People Fail Due to Fear
Emotion is one of the investor’s greatest enemies. Fear makes it hard to remain optimistic about holdings whole prices are plummeting, just as envy makes it hard to refrain from buying the appreciating assets that everyone else is enjoying owning.
It is absolutely essential to keep optimism and fear in the appropriate balance.
Fear is a great motivator, but in the market, it always on the end of the spectrum.
Howard Marks titled it The Tipping Point in his memo.
One of the most notable behavioral traits among investors is their tendency to overlook negatives or understate their significance for a while, and then eventually to capitulate and overreact to them on the downside.
Right now, we ALL knew what a mess the world was in.
There was no secret that China was being fueled by cheap financing, a slowdown in the manufacturing sector, glut of oil, indebted countries requiring cash to pay off their obligations and ongoing European problems.
We knew all this. So what’s the problem?
If markets are falling, get excited.
This is how you make money.
I’ve been asking for another 2008 will occur. Back in 08, I didn’t have much to invest with, so in terms of wealth, it didn’t move the needle much.
This time around, I have more ammo and I’ll be going into berserko mode if the opportunity comes.
While everybody is busy reading headlines and being fearful, read reports, financials, ratios, industry information.
Arm yourself with knowledge and preparation.
Use fear as a motivator. Just don’t submit to it.
People Fail by Not Following a Proven System
On a more practical note, having a system in place is vital.
A streamlined method that you follow to analyze stocks.
Working to remove greed, incorrect confidence and ignoring fear driven noise is all good, but what’s the point if you just read about these things, acknowledge it but fail to take action and implement it.
I’ve prevented countless mistakes by simply skimming a checklist because the curse of familiarity led to a lot of assumptions and “I know that” syndromes.
Try this exercise.
Only requires you do to it once.
Next time you find a stock, write down each step you take in your analysis process.
When you’re done, that’s your current system.
Look at your system and you’ll be surprised at the number of gaps in your analysis.
You can do this multiple times to create separate systems and processes according to how you perform:
- initial research
- full analysis
- selling decisions
The only proven system is the one that works for you.
Whether you copy one and customize it to your needs, or create your own, it’s up to you.
Just not having one is why so many people fail in the stock market and cry bloody murder.
Even if you follow a simple approach like the Magic Formula, or something like the new OSV ratings and grading system, it’s a system that will help.
Although the start of 2016 has been ugly, each of the Q,V,G and Action portfolios are doing well by losing less than the market.
People Fail by Not Using the Right Tools
Having a personal approach or philosophy is an essential first step, but you also need the right tools that will help you implement your approach.
Depending on your style of investing and your needs, there are lots of tools out there that will help you get better fast, do things quickly and help you focus on the important things.
Paying $2.99 to have Buffett’s shareholder letters in Kindle format that I can read on the plane or during my recent vacation was a no brainer.
Yet, there are others who will spend 20 mins to download, rename and save it to their computer and never read it – because they don’t have access to it.
Info hoarding.
As a value investor, I understand the need to save money, but not at the expense of wasting hours of time for something that doesn’t add value to the analysis or my day.
If you need to mow your lawn, you don’t pull out your trusty scissors.
You go for the lawn mower – because it’s made to cut the lawn.
I recently signed up for MicroCapClub to make it easier to study and learn about microcaps.
$497 a year is expensive for a lot of people, but when you break it down to about $40 a month to get access to experienced and battle-tested micro cap investors, their experiences and other hidden content, it’s a no brainer.
I’d rather spend $497 to learn a valuable lesson and prevent a $4,970 lesson.
If you’re looking through a lot of filings, you don’t pull out a fork to sift through the documents. You need something like a leaf blower or at least a rake to get the job done quickly.
Bamsec.com and seclive.com make this easy.
But it’s all pointless unless you actively invest.
No point in buying a lawn mower if you don’t own a home.
So even with Old School Value, as much as I believe in the tool, it’s not for everybody.
However, if you are serious about wanting to become a better investor without having to rely on other people for analysis and information, then look into Old School Value.
This week, I’m rolling out an early beta program of Old School Value Online (FINALLY) to a small group of people and will slowly expand it.
I can’t fit everybody in right now because it’s still in the early stages, but 135 members jumped on the list within a few hours from an email that I casually sent last night to members.
That’s 135 eager and active investors who understand the importance of their time, process, focusing on the important things and getting an edge in a zero-sum environment like the stock market.
Much like that investment manager from the story earlier.
