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Why I'm Down More Than 75%, and How You Can Avoid My Mistakes

As any member 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 the 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 does an analyst like me have to lose?

I hope two things come of my story:

  1. Someone, somewhere out there learns something from my mistakes.
  2. Having studied psychological commitment and consistency in Dr. 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 (NYSE: AIB  ) . To date, I'm down 78% (not long ago, I was down more than 90%, but the stock has inched upward).

That's not as big of a loss as those suffered by investors in YRC Worldwide (Nasdaq: YRCW  ) , Repros Therapeutics (Nasdaq: RPRX  ) , and Pacific Capital Bancorp (Nasdaq: PCBC  ) over the past year -- but still, it hurts.

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

Perhaps the only comforting thought can be found in Warren Buffett's 2008 Berkshire Hathaway annual report. Buffett writes that he also suffered a significant loss by investing in Irish banks. Some have speculated that AIB was among them. If 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.

Before my purchase of Allied Irish Banks, it had been recommended in our Global Gains newsletter service and purchased by the team heading up our real-money Million Dollar Portfolio 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 began purchasing Allied Irish Banks 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 Allied Irish Banks 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 persuading 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, 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 Allied Irish Banks 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 Allied Irish Banks had risen 78%, 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. Palm (Nasdaq: PALM  ) might have seemed like a bargain at the start of 2009, when it was down more than 50% from the previous year. But it doesn't seem like it would have been wise to buy it -- the stock is down another 50% over the past 12 months. Sulphco (AMEX: SUF  ) and Cardium Therapeutics (AMEX: CXM  ) shared a similar fate. 
  3. It's best to simply bypass investments that are too complex, or that you're not certain 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 still owns shares of Allied Irish Banks. The Motley Fool owns shares of 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 (7) | Recommend This Article (24)

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 March 30, 2010, at 1:16 PM, wrongdog wrote:

    when was this written?

  • Report this Comment On April 05, 2010, at 5:07 PM, dathompson wrote:

    As stated at the bottom of the article (in italics) ...

    > This article was originally published April 14, 2009.

    Apparently the article has was recently updated.

  • Report this Comment On April 14, 2010, at 10:08 AM, Flightequipt wrote:

    By Buying something that is going down, you did get caught in the "value trap." and as it went down it even looked better according to your criteria so you probably averaged down and threw more money in the hole. If you want to learn how to stop that, buy stocks that are trending up! If it turns against you sell it fast and cut your losses. If it continues up ride until you are sure the trend is over. The only fundamental you should be concerned with is the price and trend. The price is the aggregate view of the fundamentals and the trend the picture of which direction that view is changing. Regards, Flight, of

  • Report this Comment On April 14, 2010, at 10:18 AM, Flightequipt wrote:

    In Addition, I'm up 20% in PCBC right now. Try these, BEE, added to my watch, 03-15-10 up 78%, WNC 03-15-10 up 55%... Now watching, LAKE, ROHI, SFI, MSPD, LXP, LAVA as of 4-12-10

    A body in motion stays in motion... Physics...

    GLTU, Flight,

  • Report this Comment On June 05, 2010, at 12:39 AM, jennifergmd wrote:

    And I should trust you about the price of Gold? You get what you pay for on this site..

  • Report this Comment On September 17, 2010, at 1:05 PM, bricks79 wrote:

    Time to buy AIB with a five year hold. You should get a 250% return as this is one of Ireland's too-big-to-fail banks. Patience is the key.

  • Report this Comment On September 17, 2010, at 1:12 PM, Superdrol wrote:

    This is funny.

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