There's No Substitute for Real-World Experience in Investing

I thought I knew everything.

Immediately following graduation and student teaching, I accepted a teaching position at a high-achieving charter school in inner-city D.C. Being hired straight out of college was rare, and I thought that meant my natural skills were blatantly obvious to the principal who hired me. I had crowned myself an all-star before Day One ever arrived.

And then Day One did arrive. I won't go through the gory details, but suffice it to say I had no idea what I was doing.

I'll always remember my overconfidence from the outset. There's a name for that: skill bias. This happens when education and training cause one's confidence to rise faster than their actual, real-world skills do.

Applied to investing
This bias isn't limited to teaching, though. It can be used in just about any situation where a certain level of classroom training causes one to believe that he or she will be automatically successful in the real world.

Studying economics in high school, college, and graduate school is great. But that alone isn't enough to deem someone a successful investor. You have to take your licks along the way. Failure isn't just the best teacher, but for those of us hard-headed enough to think we're endowed with a certain investing acumen, it's the only effective teacher.

An example from the past
One of the biggest mistakes any investor can make is assuming that they are immune to the skill bias. Following my months-long training at The Motley Fool, I thought I knew what it took to spot tomorrow's next monster stock.

Back in July 2011 -- immediately following my training -- I penned an article on six companies I thought could double over the coming months. The article did fantastically well, getting 115 recommendations and over 80,000 hits.

The problem was, my advice was terrible. In hindsight, it's pretty easy to see that I singled out six highly speculative stocks that were heavily shorted, and put faith in the fact that because I deemed them "innovative," they'd prove the shorts wrong.

Take a look at how the six stocks did over the two-month time frame, and how they've done since my article was published.

 Company

2-Month Return

Overall Return

Entropic 

(54.6%)

(41%)

Travelzoo 

(47.4%)

(66.1%)

SodaStream (NASDAQ: SODA  )

(48.7%)

(21.9%)

First Solar (NASDAQ: FSLR  )

(27.1%)

(77.2%)

Coinstar 

(17.3%)

(5.9%)

Ebix 

(13.8%)

(12.2%)

Source: Fool.com.  

Now consider that over those same two time frames, the S&P 500 returned -6.6% and 16%, respectively, and you can see how truly awful my reasoning (and overconfidence) was.

Here's what you can do
First things first. I've developed a mantra I think every investor would be well served to repeat: There's more that I don't know about the market than there are things that I do know. Repeat this to yourself every morning. It's humbling, and it puts you in your place.

Second, do a really thorough job researching your topic, investigating both the pros and cons of investing in particular companies. For instance, when I tabbed First Solar as a possible investment, I didn't give a single reason I thought the company was innovative.

If I had done my research, I would have known how much the company relied on government subsidies,  or that its panels were far less efficient than the competition's.  Since I wrote the article, First Solar's earnings have fallen 42%.  And the future doesn't look too bright, either: Earnings are expected to fall another 20% by 2014.

Finally, realize that some of what you may have been taught in school (or even through a subscription to a premium Foolish service) may not play out in the real world. Things change fast, and there's no way to predict the future with 100% accuracy. After dipping your toes in the investment waters, pick a style that works for you, and periodically revisit your approach for fine-tuning.

One that I still believe in
One company that I think still does have a lot of potential is SodaStream. Where before I saw a gimmicky product, I now know from personal experience how useful the company's carbonators really are.

The company has been able to grow earnings by 42% during the third quarter of 2012, and revenue was up a similar 43%. As SodaStream's carbonators find their way into more and more stores, I could see this trend continuing for a while.

This razor-and-blade company offers an intriguing opportunity for growth that may be harder to duplicate than you might think. Our premium report on SodaStream explains the opportunities as well as the risks in the company. The report comes with a year's worth of updates, so just click here to get started.


Read/Post Comments (5) | Recommend This Article (12)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 02, 2013, at 1:41 PM, Sotograndeman wrote:

    You are a clown. You deserve to be shot for the ridiculous article and idiotic recommendations.

    And TMF should be taken to task for allowing rubbish like this to go out under its name.

    Your belated confession/apology is of no consequence. I only hope no-one, repeat no-one, took your article seriously. Or perhaps some people did and are banging the table for revenge, and hence the real reason for this piece?

    Yet another reason to avoid TMF.

  • Report this Comment On February 04, 2013, at 12:28 AM, lowmaple wrote:

    soto Yet here You are

  • Report this Comment On February 04, 2013, at 5:41 PM, Sotograndeman wrote:

    low - gone! ;-)

  • Report this Comment On February 08, 2013, at 1:36 PM, dstwhit wrote:

    Thanks, Brian.

    I love your candor and transparency and appreciate your insights and very real-world examples.

    dstw

  • Report this Comment On February 09, 2013, at 1:30 AM, jlclayton wrote:

    No one reading an article for investment advice should ever assume that the writer is going to be 100% accurate and needs to follow up with their own research. I will listen to the opinion of anyone who is willing to admit their mistakes, invites negative and positive commentary, and tries to help others learn from their experiences.

    Thank you!

Add your comment.

DocumentId: 2225415, ~/Articles/ArticleHandler.aspx, 4/21/2014 6:29:46 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement