Why I'm Down More Than 80%, and How to 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 bear market has been my investment in Allied Irish Banks (NYSE: AIB  ) . To date, I'm down 81% (not long ago, I was down more than 90%, but the stock has inched upward). And unfortunately, due to the Irish economy's sluggish recovery (not to mention, an unemployment rate of 12.7%), prospects for the bank don't look good.

However, as painful as this 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 (NYSE: BRK-B  ) 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. Unfortunately, his 2009 letter fails to mention whether he held this Irish bank, so we can't be sure whether he believes it's smart to hold, or whether selling is the smart choice.

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 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 81%, 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. Blockbuster (NYSE: BBI  ) might have seemed like a smart contrarian bet at the start of 2009, when it was down more than 50% from the previous year. But it wouldn't have been wise to buy it. The stock is down another 50% over the past 12 months on continuing fears of bankruptcy. Quite simply, it is tough for this company's leveraged balance sheet to compete with Netflix's (Nasdaq: NFLX  ) leaner business model. Not to mention, Blockbuster is losing market share while Neftlix's share of the market continues growing. Shares of Student Loan Corp. (NYSE: STU  ) , which has had to continue raising provisions for loan losses, have shared a similar fate, and will likely continue struggling going forward. 

  3. It's best to simply bypass investments that are too complex, or that you're not certain you solidly understand. This is advice investors in Citigroup (NYSE: C  ) and Bank of America (NYSE: BAC  ) would have benefited from several years ago. Many assets on their balance sheets were impossible to value, and the risks associated with owning those assets were therefore impossible to assess. And to date, not much has changed. Meaning that, even though shares have multiplied many times over off the bottom, investors shouldn't fall prey to believing these are "simple" or "easily understood" companies.

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. Netflix is also a Stock Advisor pick. The Motley Fool's disclosure policy likes to learn from its mistakes.

Read/Post Comments (14) | Recommend This Article (15)

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 April 30, 2010, at 5:35 PM, jesterisdead wrote:

    Good advice. Thanks for sharing. Refreshing to hear actual experience vs bull or bear marketing from most articles.

  • Report this Comment On April 30, 2010, at 8:46 PM, profittkr wrote:

    Wonderful advice. I have often complained that the folks running this site have gotten way too full of themselves....or something that drops from cows. In line with the real estate hucksters that populated the Sat. am shows 2 years ago -you ask - if they are so good at doing what they are doing, why not just make a living thru that rather then pitching ideas to everyone else? The obvious answer is its HS. the only true value of this site is the collective wisdom of the Fools -and by that, I mean the chance to frontrun their possible cumulative intent to buy recommended stocks.

  • Report this Comment On May 01, 2010, at 12:37 AM, hdotmom wrote:

    I guess I don't understand the services you offer. I thought your services told one what to buy, when to hold, and when to sell. I understood that I didn't have to learn how to figure this all out myself. I'm really not sure what I have paid for. If I have to research it then I can just read your headlines and do my own research.

  • Report this Comment On May 01, 2010, at 12:59 AM, Superdrol wrote:

    More than anything else I think this should be a lesson in risk management. In terms of longer term investing you should have a line in the sand loss. Mne is 7% but it can vary from person to person.

    Being wrong is fine. You don't always get it everytime. Staying wrong is unacceptable though.

  • Report this Comment On May 01, 2010, at 1:54 AM, paraguy12 wrote:

    Citi bank is a great buy right now people. And once the Gov is out there is going to be a share buy back not a RS like some believe. And here is my early xmas gift to whoever wants it that is. Citi is allready buying back shares from the Gov in a way that they dont have to report it. But it will leak out soon then the share price will sky rocket. I seen an abundance of calls for $35 for unreal amounts. Crazy you think... me think not.

  • Report this Comment On May 01, 2010, at 10:16 AM, cstash wrote:

    nothing is guaranteed in this world, and the more risk you can tolerate the greater reward you will expose yourself too. I subscribed to million dollar portfolio in the past and the reason it remains the past, was because of the lack of coverage on some of these companies that are being written about. The only thing that saved me, was not following the newsletter reccomendations. I came up with my own brainstorms and it worked for pulling me out of the million dollar portfolio hole that I dug myself in. I still like the companies but do not like the reccomended stradegies as far as managing the portfolio.

  • Report this Comment On May 01, 2010, at 12:21 PM, Teacherman1 wrote:

    Keep holding it and you will still make money on it.

    Since you didn't have a stop loss position to take you out when it cratered, you are better off waiting. You have already taken your loss (on paper), why turn it into a "real one".

    When all the dust settles, IRE and AIB will be two of the cleanest banks anywhere. They will be smaller, and it will take some time for the Irish economy to come back, but I firmly believe it will.

    And yes, I have done my own research.

    This appears to be almost the same article you wrote and posted some time ago. I told you the same thing then.

    JMO and worth exactly what I am charging for it.

  • Report this Comment On May 01, 2010, at 7:01 PM, ckfinance2003 wrote:

    re: hdotmom No one can tell you what to buy, when to hold and when to sell. If it was that easy there would be a million Buffets not one! The best any advice can be is a starting point. You have to use your own judgement too.

  • Report this Comment On May 02, 2010, at 5:03 AM, SanElijo wrote:

    The author is right. Do your own research and know the company. More importantly though, the author should learn how use his research to understand and estimate intrinsic value.

    I also bought AIB too high, at an average priced of $18.00/share, failing to anticipate the precipitous collapse of the financial system, and bloated nature of the Irish real estate market. A lot of us missed this! However, I made a modest profit in the end because I was able to make rough value calculation.

    I recovered my losses for a modest profit by buying a big lot of shares for $1.50/share (they dropped all the way to .90), by estimating correctly that the government would step in and support AIB. AIB was better shape than Anglo which was nationalized. More importantly, I estimated the value of AIB's share of M&T, something short of 1 billion in future value, was safe, and not recognized in the panicked price, as well as the modest value of the Polish branches, which AIB could sell to raise capital.

    I ended up closing out my position when the stock price became over-inflated around $8. It was very small profit at the end of a roller coaster.

    For the record, I do have a background in finance. Maybe that helped. Not panicking and making a cautious and reasonable estimation of value helped more.

  • Report this Comment On May 02, 2010, at 10:58 AM, cstash wrote:

    teacherman1: when you were writing about your stop-loss position, did you mean you owned aib with a stop-loss sell order in place? I myself do not like useing stop-loss sell orders with volitile stocks, example if your order is tied to pre-market trading, these stocks will move all over the place for no reason at all except for manipulation. And if it isn't pre-market did you know that market orders are executed before a stop-loss will be triggered?

  • Report this Comment On May 02, 2010, at 3:51 PM, rru2s wrote:

    With each investment, I look at how much I can afford to lose if things really go south (X% of portfolio), and estimate how far they it might drop before I'd get out. For example if I cannot tolerate losing more than 10% of my portfolio from losses in one company that as a worst case might drop 50% before I sold out, then my risk tolerance would be 20% of my portfolio for that stock, no matter how sweet the story sounds.

    That being said, I tend to diversify into mutual funds for 40 percent of my portfolio, individual large companies for another 25 to 45 percent, and small caps for the remaining 15 to 35 percent. The small caps are the most dangerous. I tend to not invest in a small cap unless I understand the business (sector demand, profit margins, debt/cash, and derivative warrants/preferreds effects). There are a lot of small caps I avoided because I wasn't sure of the stability of their revenue stream or competitive moat, and others I avoided because of accounting glitches. Because I follow the news every single day on a microcap, I limit myself to one or two in my portfolio at a time, I could get burned if I get lazy about following them closely.

  • Report this Comment On May 03, 2010, at 8:00 AM, jb757 wrote:

    It doesn't matter which popular "investment services", e.g., Motley Fool, Jim Cramer, or others, are offering advice. The bottom line is that they review so many stocks (that's their business) that on the average I'll bet that 1/3 go up, 1/3 go down, and 1/3 remain in sleep mode. Companies with past, present and future earnings power and little or no debt always offer the best chances for gains and diversification is important. You don't need any advisor to tell you that. It's common investment sense.

  • Report this Comment On May 07, 2010, at 11:53 AM, SteveTheInvestor wrote:

    Yeah, and it's just too bad that on MF boards so many will tout "staying the course" when a "great" stock tanks. More than once I've commented that I sold a stock that had tanked. AIB was one of them. I think I lost 17% on this one.

    I specifically remember saying that a particular stock had dropped 40% and that I was done with it because it could easily drop another 40%. I was wrong, it didn't drop another 40%. It dropped another 60%.

    Still, I was called out by numerous people as not having the proper "temperament" for investing. AIB, like soooo many others has been a crap stock, let's face it. For many people that bought when this thing was a five star stock, they will likely never get their money back.

    Being a long haul investor is one thing. Being reckless for the sake of having the right "temperament" is something else.

  • Report this Comment On May 08, 2010, at 11:17 AM, Teacherman1 wrote:

    cstash- Don't have and would not have a "stop loss" in this price range. I was referring to when it was flying high.

    I assume he bought it in the $20.00 range, if he had that big of a loss.

    I would not have bought it at that price.

    I have more of a tendency to sell too soon, than to buy too high.

    Don't know if that answers your question or not.

    Of course, with what has been happening lately, I did not have low enough limit buy prices, so a number of picks popped up in my portfolio in the last week, that I will be closing asap. I do not own all of them, and my portfolio as shown in my picks is usually matched by my real life portfolio.

    I like the stocks that were picked, but did not like the prices enough to buy them at that time. I had start limits set about 20% lower but was really busy last week and did not adjust them downward when the market started dropping.

    I will be buying them, but since I don't own all of them at this time, I will be closing some out.

    In the meantime, my accuracy and rating is taking a real beating. Luckily, my real life holdings aren't. I'm down some from my highs, but not with losses.

    Have a good day.

    Please excuse the ramblings of a tired old man in need of a nap.

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