Lesson 1: The two paths of hindsight
The Good Path: Looking back at my portfolio moves I would remember those times where I would high-five myself after watching some of my picks make double digit percentage gains. This would then be followed by a mental battle to remind myself that I didn’t know everything, and that good things don’t last forever (Turkcell TKC, Southern Copper SCCO, DeVry DV). There were times when some of my picks performed badly (Trimeris TRMS, Research in Motion RIMM, Herman Miller MLHR). By maintaining a sense of humility, it kept me safe from making any severe moves, either positive or negative. It was conservative, but considering what happened during this time frame it allowed me to sleep at night. Backing away from the emotion of wins and losses seems to have helped me navigate the turbulence.
The Bad Path: Looking back at all my realized investment picks (stocks bought and sold) 77% of my picks made money. The bad path of using hindsight is to get caught up in a self-fulfilling prophecy. To look at that 77% number, drink my own kool-aid, and run around shouting like some CNBC prophet. It’s easy to fall into this trap and believe that your “system” of investing works when everything seems to be working. After three years of this experiment though, I realize that the system that worked for me over this time period may have only worked for this time period, and quite frankly may have just been based on luck and the convenience of being busy with my real day job. There were a lot of land mines over the past three years, but there were also significant opportunities. The question I ask myself is whether I would have lost more if I participated more? In any case, the bad path is to look back with hindsight and believe that what I did was right and that it will continue to work. Constant adjustments are needed. I’m not sure what the next three years will bring. It’s all new territory.
Lesson 2: If you don’t have a playbook, you can’t do anything
There’s something fascinating that I love about football. That is the playbook. Coaches and players need to memorize it, run the plays during practice, and make calls/adjustments according to the opposing team’s “looks”. It’s a game based on strategic adjustments that is based on a good understanding of the playbook. Now imagine a player or coach who doesn’t know which play to call. Bad things happen. The same thing applies to making the right investment picks. At the start of 2008 I started to develop my play book. I was digesting economic reports, listening in on earnings calls, making notes, reading the journals, etc. I was developing my plays and from that I made some good picks. The problem was that as the year progressed, and one year bled into next, my personal life and day job took over all my time. The playbook got stale, at which point I couldn’t pull any trigger with any sense of confidence. This problem reared its ugly head when I had no play book at all during the market lows of 2009. In one of the biggest stock market sales of our lifetime, I was paralyzed. I only made 5 purchases that entire year. Many opportunities were missed. Many high quality companies were on sale during 2009 and I’m now kicking myself because of it. I’m hoping to make this correction this year by maintaining a small playbook set through 2011.
Lesson 3: Turn off CNBC, and read
I shut off CNBC in 2008 and have never looked back. There is much more context and quality information in economic reports, earnings calls, and quarterly/annual reports. CNBC is “investortainment”, and that stream of noise poses a distraction. What works is pure focus. No noise. Just shut off the TV and just read, read, read.
Lesson 4: Don’t get caught up in the fundamental/technical/chartist religious fight
I started to delve into the world of fundamental valuation, technical analysis, and chartists techniques. I never realized just how bad the fight was between these camps until I started doing my own research. I’m comfortable with fundamental valuation. I don’t know how to do technical analysis, nor do I know anything about chart patterns. Those techniques most likely work, but I don’t know how to use these tools so they’ll just have to wait for now until I can get more research under my belt. Knowing how to use the tools is more important than trying to claim one system is better than the other.
Lesson 5: It is a hard road without a team
I work solo. I don’t follow stock tips from my friends and family, and I do all the research alone. The problem is that this model doesn’t scale. It’s the main reason why I never had a good playbook the past few years (see Lesson 2). It’s a hard road. I don’t have enough time. I can’t cover every industry, every economic report, and every earnings call for my stock positions. This is where mutual fund companies armed with an armada of analysts win. The only advantage I have is that I get to analyze whatever I want, when I want. You don’t get that luxury when working for “the man”. So maybe there’s an equalization factor here that helps level the playing field, but it is still hard to do this without a team.
Lesson 6: Outperforming the S&P500 is extremely HARD
If you’ve read books by Makiel, Bogel you’ll understand that outperforming the S&P500 over the long term is almost impossible. Even with such sage advice, I decided give it a go. “I’m different; maybe I can outperform the S&P500. Let’s take $10,000 and give it a whirl.” - yeah right. From a total gain perspective, I managed to outperform the S&P500 but that is based on placing a $10,000 bet on the S&P500 in January of 2008 and walking away versus my actively managed portfolio. The final result: 16.46% for the actively managed portfolio versus a 14.4% loss in the S&P500 index.
But is that really a fair fight? Not really. If I took $10,000 and split it out over several purchases (dollar cost averaging) and bought into the S&P500 index over the 3 year period I would have done better than trying to actively manage my portfolio. I would have been able to sleep better, play golf, go swimming, ski, hang out with my kids, and watch football. I would have had a better quality of life because I wouldn’t have had to do any investment related research. Back testing the dollar cost averaging method over the same time period and you can clearly see the results. After taxes were taken out and dividends accounted for, the systematic purchases of the index (SPY ETF in this case) whether daily, quarterly, monthly, or even annually would outperformed the Ten Grand Chicago portfolio.
Lesson 7: Uncle Sam loves to eat your cake
I made 22 trades over 3 years to try and stay afloat, and Uncle Sam loves to take away a big chunk of those gains. Even for positions that I held for over a year, the maximum capital gains tax is 15%. That’s a lot better than what it used be (20%), but 15% is still 15%. It’s a big bite. Taxes are a reality, and rather than making trades I need to do a better job investing, rather than trading. As can be seen from the previous lesson, I wouldn’t have had to pay any taxes in a systematic purchase of the SPY ETF other than the dividends received.
Lesson 8: The free market system works when all hope is lost
On March, 5th of 2009 the world seemed as if all hope was lost. People weren’t sure if the banking system was intact, the US auto industry was in complete disarray, and people were losing their jobs and their homes. I still bought the S&P500 by taking a small position in the SPY ETF. It just so happened that this day was the lowest point for the index over the past 3 years. That was pure luck. What wasn’t luck was the reason why I bought into the index. I bought into the 500 companies represented by this ETF because I still believed in the free market’s system of checks and balances. For every mistake, there exists a system where a correction is made. From Enron to Lehman Brothers, people are brought in to face the music. Sometimes the knee jerk responses made by officials crimp the liquidity system, but that doesn’t last forever. Things find a way of working themselves out. Looking back at the S&P500 the past several decades you can see how resilient it is at dealing with shocks to the system. In 2009 I did a little study to see how big a percentage gain the S&P500 would make one year after hitting bottom in previous stock market crashes. We’re finally climbing out of the financial crisis and history repeats itself again. The lesson learned? The S&P500 index is a good place when all hope is lost. We will probably never see a sale like this for a really long time. The percentage gains one year after hitting bottom from the last 3 crashes:
Lesson 9: Betting against something you like doesn’t pay.
The very first I stock I analyzed was Amazon (AMZN). I decided to check them out because I loved their service but I also believed they were extremely overvalued. I’ve had this dance with Amazon since 2000 where I continue to buy stuff from them, but I’ve always thought there stock was extremely overvalued. You would have figured that over the past 10 years I would have learned something.
I did the analysis back in 2008 and decided to stay away. I argued again that the stock was overvalued and the company’s addiction to fund free shipping and margin pressures concerned me. The valuation simply didn’t work and I stayed away. Things looked great in 2009 as Amazon’s stock slid as did everything else, but the company still continued to generate the revenues and profits during the downturn. The company’s stock has roared back big time since 2009.
This lesson is simple. If you like a company’s product/service, but their stock valuation is out of this world… just stay away. Bet for it, and you may suffer from “I love this company, nothing can go wrong” bias. Good things don’t last forever. Bet against it (short), and you may get wiped out while you hope for a correction.
So that’s 9 lessons learned. Time to move on to 2011.
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