Why I'm Down More Than 70%, and How to Avoid My Mistakes

As any graduate of Alcoholics Anonymous knows, the first step to setting out on the proper path is admitting your weakness.

In that spirit, I'm writing about my biggest mistake during this bear market. Here. Publicly. For the whole world to see.

After all, if legendary investor Peter Lynch of Fidelity Magellan fame could publicly admit to holding AIG and Fannie Mae at the end of 2008, what's an analyst like me got to lose?

I hope two things come of my story:

  1. Someone, somewhere out there learns something from my mistakes. Feel free to consider me a sacrificial teacher.
  2. Having studied psychological commitment and consistency in Robert Cialdini's classic work Influence: The Psychology of Persuasion, I hope that my public commitment to avoid repeating these mistakes prevents me from falling victim to them again.

Mea culpa
My greatest investing failure of the past year has been my investment in Allied Irish Banks. To date, I'm down 71% (not long ago, I waved goodbye to more than 90% of my initial investment, but the stock has recently inched upward).

True, it's not quite as big a loss as those suffered by investors in CIT Group (NYSE: CIT  ) , Sequenom (Nasdaq: SQNM  ) , LDK Solar (NYSE: LDK  ) , Evergreen Solar (Nasdaq: ESLR  ) , and Ambac (NYSE: ABK  ) over the past 12 months, but what consolation is a few percentage points' difference when you've lost 71%?

And yet, painful though that loss is, seeing how avoidable this was in hindsight hurts even more.

Perhaps the only comforting thought is that in Warren Buffett's most recent Berkshire Hathaway annual report, he writes that he also suffered a significant loss by investing in Irish banks. Some have speculated that AIB was among them. So at least I was fooled alongside a much better investor.

Following the crowd
I first went wrong in falling prey to social proof. I put too much weight on the research, opinions, and actions of others, without thinking through my investment decision for myself, and deciding whether it made sense in my portfolio.

Prior to my purchase of AIB, it had been recommended by our Global Gains newsletter and purchased by the team heading up our real-money Million Dollar Portfolio real-money service. Advisors in both services wrote that the stock was trading with low historical and relative multiples, a very attractive dividend yield, and a significantly undervalued price.

While they made compelling arguments, I failed to carefully evaluate whether I agreed with their assessments. And I became even more hooked as these fellow analysts also began purchasing AIB for their personal portfolios.

As a result, I also began to give in to confirmation bias -- where I sought out opinions that further confirmed my buy decision, rather than seeking a contrarian opinion that might indicate danger ahead.

Seth Jayson, co-advisor of our Motley Fool Hidden Gems newsletter service, recently shared with me that confirmation bias is one of the most common predispositions investors face. He explained that truly great investors develop an ability to honestly look at both sides of an investment thesis.

Anchoring in loose sand
As if those errors weren't enough, I also became anchored to the price at which each service recommended the stock. I fixated on those price points; in my mind, anything lower than their entry prices became a clear bargain.

So, when AIB fell another 50% from the most recently recommended price, the stock became twice as attractive to me, as did the doubled dividend.

These mistakes fed off each other, collectively convincing me to overlook my normal investment process. I took shortcuts. I failed to perform as much research as I typically do. I fell in love with the stock, viewing it as mostly upside, without truly understanding the risks and pressure points. And I didn't even consider the possibility of a suspended dividend (which later came true).

The company -- which, hurt by the falling Irish economy, recently needed to boost its construction and development loan reserves -- was much more complicated than I originally thought. Andy Cross, also co-advisor at Hidden Gems, recommended to me that investments should always pass what he calls "Einstein's razor," which dictates that an investment thesis "should be made as simple as possible, but no simpler." The complexity of AIB forced me to look to other investors, bypassing my own investment process.

Lessons learned
The key takeaways from my mistakes, then, are:

  1. While it can be helpful to look at the opinions of others, you still need to carefully consider whether you agree with their investment theses. Even if AIB had risen 71%, it still would have been a mistake for me to buy it, because I hadn't sufficiently examined the reasons for owning it. You must be able to distance yourself from the positions of people you respect.
  2. It's much better to leave a stock's price history out of your analysis, so that you're not tricked into a value trap. Companies can, and often do, change. Regions Financial (NYSE: RF  ) might have seemed like a bargain at the start of 2009, when it was down more than 60% from the previous year. But it wouldn't have been wise to buy -- the stock is down more than 30% from the beginning of 2009. UAL (Nasdaq: UAUA  ) shared a similar fate.
  3. It's best to simply bypass investments that are too complex, or that you don't believe you solidly understand.

These takeaways -- and countless other investor psychology topics -- are heavily studied by Hidden Gems advisors Seth Jayson and Andy Cross as they seek out the world's top small-cap companies. That has now become an even higher priority for them as they construct a real-money portfolio of their best small-cap ideas for our Hidden Gems newsletter service.

Not only can you see their buy guidance right now, but they're also offering you the chance to read their research so you can see if you agree with their analysis. Click here for a free guest pass -- there's no obligation to subscribe.

Already subscribe to Hidden Gems? Log in here.

This article was originally published April 14, 2009. It has been updated.

Adam J. Wiederman owns shares of Allied Irish Bank and Berkshire Hathaway. The Motley Fool also owns shares of Allied Irish Banks, a Global Gains recommendation, and Berkshire Hathaway, an Inside Value and a Stock Advisor recommendation. The Motley Fool's disclosure policy likes to learn from its mistakes.

Read/Post Comments (12) | Recommend This Article (21)

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 August 14, 2009, at 7:09 PM, Alwayzwrong wrote:

    I always do a post mordem on all my trades. Even the profitable ones, particularly if I sold too early, which is a common mistake of mine.

    Slowly, but surely, I've sold closer to short term tops, and let momentum carry me further, rather than hedging to often.

    My biggest mistake of last year was GMST. I went against the crowd and felt (after days of research) that the merger with MVSN would go through. It did, but I managed to end up with a loss. I hadn't voted to redeem my shares for cash, which 98% of sharholders did.

    So, I picked a great investment. Did my due diligence. Had everything work exactly as I planned. And managed to be in the 2% of fools and lose money.

    Moral of the story: anything can go wrong; see it to the end (and if you can't....get out).

    AND never trust your broker.

  • Report this Comment On August 15, 2009, at 1:42 AM, vgaymer wrote:

    Perhaps, but I think the biggest reason by far for AIB's decline is guilt by association with the nationalization of Anglo-Irish, as witnessed by the concurrent drop of IRE as well.

    It was during the time that AIB had it's most precipitous drop. I'm not sure how much company-specific DD would have helped that scenario.



  • Report this Comment On August 15, 2009, at 4:37 AM, footchester wrote:

    As another *fool* with a 70% + loss on AIB, I am happy to share the responsibility with the GG team who WE PAY to uncover and confirm these recommendations. And with AIB receiving an unprecedented 3 "BUY" recommendations at GG, there should be an engraved "oops" sent to all members, with a REALLY nice fruit basket.

  • Report this Comment On August 15, 2009, at 6:36 AM, grendeth wrote:

    Good article, one that we can all learn from.

  • Report this Comment On August 15, 2009, at 11:03 PM, piggybank819 wrote:

    I don't know about others. I sold all my positions in Bank of America and AIG during 2nd and 3rd quarters of 2007. I don't understand why people keep holding on to their shares in a lot of financial and insurance companies when the housing market was so crazily hot. I for one do what most people don't do. I was so scared of the very fact that our saving rate was negative before the end of 2nd quarter of 2007. The credits given to the average American household were extended far too crazily. It seemed to me that both banks that gave our a lot of credit lines, personal loans and mortgages would face problems soon. Then, the companies which insured those loans that bank make, such as mortgage would likely to suffer also. Boy, do we need anyone to let us know something was cooking there in 2007? It is all common sense and how sharp we are as investors. Some people learn it in the 'easy' way, some people learn it in the 'hard' way. Then between February and July, I bought back GS, AIG, C, BAC, F and LVS too when other said that they were to disappear. Also, CIT is not going to say goodbye. For those who don't believe in the notion that our 'free economy' can right itself without the help of Government, CIT, LVS, HOV, BZH are not for you. Good luck to all.

  • Report this Comment On August 16, 2009, at 12:50 AM, manishkumar wrote:

    Business prospects for Banks move in strong correlation to the underlying economy of that country. Ireland benefited from initial outsourcing wave - where it was the outsourcing destination of choice for Europe. Now with China and India picking pace, Ireland is suffering and this is unlikely to change in near future.

  • Report this Comment On August 16, 2009, at 3:56 AM, jolaz wrote:

    When trading individual stocks, you have to set points where you get out. I use the 10% rule. If a stock I own drops 10%, generally I'm done with it. Sometimes I amend my rule to 15 or 20% if it's true love -- it really depends on the upside potential I see. As for averaging down, that works great on average 50% of the time.

  • Report this Comment On August 17, 2009, at 9:19 AM, pedorrero wrote:

    OP has written a good article. However, I take issue with the concept that anyone should "graduate" from AA. Indeed, some of us say that if you "graudate" you'll ususally go right back to drinking, with all the lousy outcomes that brought most of us to AA in the first place. AA is offered as a rest-of-life refuge from the problems of drink. OK, to apply this to investing? Research cognitive errors. ("Behavioral psychology" and similar) and try to avoid them. Good luck!

  • Report this Comment On August 19, 2009, at 12:31 PM, jkgraham1 wrote:

    Every action is the stock market can be veiwed as a mistake:

    1. You sold too soon

    2. You bought too late.

    3. You should have bought more.

    4. You shouldn't have bought at all.

    If you think about too much it will drive you crazy.

  • Report this Comment On August 23, 2009, at 6:07 PM, frorule wrote:

    So, in reality your portfolio isn't down 70%, just this one stock. It sounds like you diversified, so big whoop. Lots of people lost lots of money last year.

  • Report this Comment On August 26, 2009, at 11:03 AM, acguitarte wrote:

    I'm a newbie but investing isn't too different from betting on the roullete. You lose some you win some. You just need to know when to get in and out. Or when not to bet and wait if it's getting too hot. My goal at a minimum is to even it out but a little profit should be enough; but a huge profit is simply icing on the cake.

  • Report this Comment On August 26, 2009, at 11:18 AM, urmoneyurlife wrote:

    You do not really understand something unless you can explain it to your grandmother.

    -Albert Einstein

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