Mistakes are inevitable when it comes to stocks investing. Even Warren Buffett has made numerous investment mistakes over his storied six-decade career. So even if the greatest investor of all time makes multiple mistakes, all of us will too at various points on our investment journey.
So the real question is not whether we will make any mistakes along the way (you will), but how you respond to your mistakes when you make them. Here are four things to do when you make a mistake with your stock investment.
1. Accept that you’ve made a mistake
This is probably the easiest and hardest step to take for many investors. It is the easiest step because all you need to do is to simply acknowledge that you’ve made a mistake. It is also the hardest step because many investors refuse to acknowledge their mistake in the first place.
Do you know of anyone who bought a losing stock and continued to hold onto it even though it was clear as day that the stock would never recover?
I made this same mistake myself when I invested in Citigroup during the Global Financial Crisis in 2008. I lost over 90% of that investment when the cards fell, but I continued to hold onto the stock for years because 1) I refused to admit the mistake, and 2) I was hoping that the stock price would one day recover.
I eventually sold the stock when I realised that Citigroup was never going to grow 10 times in size for me to break even on my investment. (And it if you look at Citigroup’s price chart today, the stock never recovered from the financial crisis.) However, the years of holding onto a dead stock meant that I missed out on the potential gains I could have earned reinvesting my money in a new, high-quality stock.
2. Reverse-engineer the mistake
How did you make that mistake? Were you greedy? Did you take on too much risk?
In my case, I didn’t fully understand my investment. When I invested in Citigroup, it had already crashed 50% from its peak. (Keep in mind that the entire U.S. stock market also crashed by half during the Global Financial Crisis.) I thought I was getting in at a great price – that I was doing ‘value investing’.
I still saw local Citibank branches serving clients; I still saw Citibank credit cards everywhere; and I believed that the bank wouldn’t go out of business. However, the reality was that I didn’t fully understand the business of a global banking conglomerate like Citigroup. And I definitely didn’t know much about the toxic assets that lay hidden on the bank’s balance sheet.
When I finally admitted my mistake and looked back in hindsight, I realised I only understood the surface of my investment in Citigroup. I had no idea what I was getting into.
3. Improve the process
After you’ve examined and pinpointed your mistake, it’s important to improve your investment process so you don’t repeat the same mistake. From my Citigroup catastrophe, I learned I personally needed to fix three things:
- Price ≠ value. A drop in price doesn’t automatically mean that a stock is ‘undervalued’. Remember, Citigroup had already fallen 50% before I went in. But its intrinsic value was lower still because of the toxic assets on its books.
- Do your due diligence and research. I thought I ‘understood’ the business of Citigroup from my experience as a banking customer, but I really didn’t. I didn’t read the annual reports, I didn’t pore over the financials, I didn’t fully understand the news surrounding the subprime crisis. I skipped so many steps as an amateur investor, and I ended paying for it.
- Keep to your circle of competence. In hindsight, I now realise that banking conglomerates, especially one the size of Citigroup, are extremely complicated investments to understand in the first place. They deal with complex financial instruments and derivatives; their financial statements are a labyrinth of numbers. Today, I simply stick to my circle of competence and only invest in simple businesses which I actually understand! And when you truly understand a business, only then can you judge its value accurately.
4. Move on
The final step to take when you make a mistake is to emotionally move on from it. There’s no point holding onto the mistake and feeling bad about the losses you made (after you’ve taken the time to process it). Remember, there will be new opportunities and mistakes will happen again. It’s part and parcel of investing – and life in general. The market always looks forward, and so should you!
For me, there was a period of time after my misstep with Citigroup where I was afraid to invest. Even though I had understood how and why I’d messed up, I was still reluctant to re-enter the market. I finally let go when I realised that even though I was responsible for my mistake, I no longer had to be at fault for it. Unfortunately, some people do hold onto their mistakes and never move on from them, and that can be debilitating to any future progress.
I made many mistakes as a beginner investor in my 20s and I still make them once in a while (although a lot less thankfully!). You’re not alone when it comes to making mistakes in the world of investments. Everyone slips up from time to time – even the greatest of all time. Although we can and should do our best to minimise our mistakes, what’s more important are the lessons we learn whenever we make one.
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