As any member of Alcoholics Anonymous knows, the first step to righting your wrongs is admitting your weakness. In that spirit, I'm writing about my biggest investing mistake ever. Here. Publicly. For the whole world to see.

After all, if Peter Lynch of Fidelity Magellan fame could publicly admit to holding death traps AIG and Fannie Mae at the end of 2008, what's a guy like me got to lose?

I hope two things come out 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 was my investment in Allied Irish Banks (NYSE: AIB). Having held for a few years hoping for a recovery, I recently sold my entire stake for a locked-in 89% loss.

As painful as this loss was, seeing how avoidable it was hurts even more.

Perhaps the only comforting thought can be found in Warren Buffett's 2008 Berkshire Hathaway annual report. Buffett wrote that he incurred a significant loss by investing in Irish banks. Some have speculated that Allied Irish Banks 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. The advisor wrote that the stock was trading with low historical and relative multiples, a very attractive dividend yield, and a significantly undervalued price.

While it was a compelling argument, I failed to carefully evaluate whether I agreed with the assessments. And I became even more hooked as other 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 pending buy decision, rather than seeking a contrarian opinion that might indicate danger ahead.

Confirmation bias is one of the most common predispositions investors face. And it's the truly great investors who develop the 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 the 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%, 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 pure 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.

The lesson here? Investments should always pass the Occam's razor test -- 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 and bypass 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 thinking. Even if Allied Irish Banks had risen 89%, it still would have been a mistake for me to buy it, because I hadn't sufficiently examined the reasons for owning it. You have to distance yourself from the positions of people you respect. This is something that gold investors should be cautious about today, with gold exchange-traded funds like SPDR Gold Trust (NYSE: GLD) inching higher and higher as more "investing gurus" are bitten by the gold bug. It's also something investors in Apple (Nasdaq: AAPL) should be cognizant of, since it's one of the most widely held stocks. After all, following the herd can -- and often does -- burn you.
  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. YRC Worldwide (Nasdaq: YRCW) might have seemed like a bargain at the start of 2011, when it was down more than 80% from the previous year and after it spent much of the year renegotiating bank loans (in the past four quarters, it paid more in interest than its current market cap.) But it doesn't seem like it would have been wise to buy it -- the stock remains down year to date and the company is still struggling to find its footing. Sunesis Pharmaceuticals (Nasdaq: SNSS) and Corinthian Colleges (Nasdaq: COCO) shared a similar fate and also look less than promising today.
  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 the Motley Fool Pro team, as they seek to generate absolute positive returns in up, down, and flat markets.

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

Adam J. Wiederman doesn't own shares of the companies mentioned above. Apple is a Motley Fool Stock Advisor recommendation. The Fool owns shares of Apple. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.