The Worst Thing that Can Happen to New Investors
What is the Worst Thing?
During one of my monthly gatherings with my students, an interesting question was raised.
“What is the best thing that can happen to new investors?”
I took a roundabout way to answer the question.
“I’m not sure which is best because many things can happen but I know the single worst thing is to make profit on their first investment.”
No, it was not a slip of tongue. In my opinion, the worst thing that can happen to any new investors is to make profits on their first investment. The larger the profit, the worse off they will be.
Why is that so?
It is due to the way we learn as humans. We don’t learn anything from our success, we only learn from our failures. Success tells us that we did something right and don’t need to make any more changes, while failure tells us that we made some mistakes and we need to improve. This method of learning works most of the time because most of our success are a result of making correct decisions and taking the correct actions. For example, to win a chess game, a player must have made all the correct moves against the opponent. Any mistakes might have cost him the game.
However, the stock market is one of the few exceptions where success is NOT always a result of correct decisions and actions. It could be due to Luck! Yes, you could do all the wrong things as a new investor and still make money just because you were lucky. There lies the danger as it gives new investors a false sense of confirmation (yes I am doing something right), or even worse, a sense of invincibility (yes, I can do no wrong).
I am a genius investor! I make money on my first attempt! Yippee!
When new investors go through such experiences, they would wrongly perceive their past investment decisions as correct, and they are likely to repeat their mistakes without realising that they were just lucky previously. Furthermore, with the profits from their first “successful” investment, they are likely to invest more in the next investment in an attempt to make more profits, but still committing the same mistakes.
However, luck will run out (eventually), and by the time that the investors realise their mistakes, they would have made a huge loss. In fact, the longer their lucky streak, the worse their losses as their investment amount usually gets larger over time.
Therefore, it is better to lose money as a new investor, so long the losses are kept to a minimum. The kind of loss that you can recover from. To me, that is any losses of less than 30%.
How to Learn from Losses
Now that you are allowed (in fact, encouraged) to lose money as a new investor, you will start learning and improving quickly because losses usually cause pain and the good news is we learn from pain very quickly (try touching a hot stove once).
But realising the mistake is just half the solution, the full solution comes from something I learnt in the military. It is known as After Action Review (AAR).
After Action Review
In the military, after every mission, no matter success or failure, we were required to take a timeout and conduct an AAR. Sometimes, this means conducting an AAR out in the field right after the mission.
The key to a useful AAR is to do it while the memories are still fresh because humans are notoriously bad at remembering small details of past events. Especially when the event is stressful and traumatic like completing a military mission or losing an investment. So it is best to do the AAR as soon as the event is over before the memories fade.
The purpose of an AAR is helping us to learn from our past experience. During an AAR, we assess our results, question our assumptions, and look for areas of improvement. Because without learning from this experience, we are likely to make the same mistakes over and over again.
20 Years of Experience vs Repeating the Same Experience 20 Times
Outside of the military, AAR remains useful and vitally important for me as an investor. The world is constantly changing and evolving, and to stay relevant you need to become better at your craft. In this case, finding the best investment you can.
Many times, when my investment portfolio makes a loss, I would be so focused on dealing with the loss that I didn’t take the time to reflect on it when the episode was over. Leaving out this final step of conducting an AAR had deprived me of the opportunity to learn from the experience. I was too anxious to find the next better investment to recover the previous loss, and many times, it would backfire as I would continue to make the same mistakes again. So instead of becoming smarter after 20 failures, I would just commit the same mistake 20 times over (ouch).
Therefore, after each investing failure or success, I would take some time to do an AAR. Here is an example:
- Why did I make this investment in the first place?
- Were my assumptions about the investment still valid? What has changed?
- What were the factors that cause the failure or success? Are they within or beyond my control?
- If it is within my control, how can I prevent myself from making the same mistakes again?
- With this new learning, how would it affect my next investment?
Now, I will admit that the cost of an AAR is hard to ignore as it takes time, effort and some brutal honesty to talk about your failures, while its benefits are only obvious in the future. And, the future is often a hard-to-grasp concept, as we yearn instant results (i.e. I have reflected through an AAR, now where is my money!). Hence, the idea of slowing down to take a moment to do an AAR for future benefits is not always well-received.
However, for those of us who are able to slow down and take the time and effort to do an AAR after each venture, you will gradually realise that your craft as an investor will start to improve and you will be handsomely rewarded…. in the future.
See you soon!
Investing Always,
Pete
Please refer to the disclaimer here
