The illusion of competence is an amazing brain function. I tend to think of myself as a financial genius. After all, I have raised myself from rags to riches. Sometimes my documents don’t support this view. Here is one example we can all learn from.
In the spring of 2007 I invested in small cap value stocks. Yes, individual publicly traded small cap value stocks. Probably not a great idea to begin with, I now know. I researched them and followed them before buying. They did well through the summer. I then got busy building a new practice and ignored them. As of October 5, 2007 their total value was $122K. Here is the list at the time.
As of April 18, 2008, their total value had been down to $87K. That was a scary time to be invested in the stock market. They were going lower. Some of my companies weren’t going to survive and were headed to bankruptcy. There was no financial capital available to keep them alive during the Great Recession. I could see the handwriting on the wall and so I sold. What a genius, eh? I avoided those inevitable further losses. I was down “only” 28%.
Seven of the seventeen companies didn’t survive – at least as an independent entity. There may have been some shareholder value for the few companies that were purchased but no value for those that went bankrupt. Even if I assume that all seven went to a value of zero, I would have been better off if I held onto all the stocks and didn’t panic and sell.
WLFC was worth 12.94 on 4/18/08 but subsequently went to 26.80 after stocks rebounded. PLUS was 9.75 per share on 10/5/07 but soared to 121.70 subsequently. That is a “ten-bagger.” Since I owned 755 shares my $7,361.25 investment would have gone up to $91,883.50 if I had not sold. The value of just that one stock was more than my entire portfolio value when I sold in April of 2008. Isn’t that amazing?
Indeed, if I held the entire portfolio until the bear market/recession ended, my portfolio would have been worth $147,655 instead of the $87,968.26. I would have enjoyed a 21% gain, rather than a 28% loss based on my starting value of $122K.
So what lessons could you learn from my mistakes? It is more efficient to let someone else make the errors and you just get the learning, right?
1. Don’t buy individual securities. Too many variables affect the company for a practicing physician to be able to keep up on what is going on. There are individual risks that you take and for which you are not compensated.
2. You don’t lose money when the stock market is down, you lose money when you sell.
3. Don’t sell your stocks just because the quoted market prices are going down. As Benjamin Graham pointed out, “Mr. Market” is often quite irrational.
4. It only takes a couple of exceptional performers to bring up an entire portfolio. If you take on financial risk, be sure you have a lot of upside potential to offset any losses.
5. Your mind will play tricks on you and convince you that you are a better investor (or doctor) than you really are. Have some reality checks in place (transaction reports, board exams, etc.).
6. Small value stocks may pay more than the average market return, but that increased return comes with enhanced risk and volatility. If you can’t stomach the volatility (as I apparently could not) then don’t go there.
7. When stocks are dropping and there is no bottom in sight and you feel only panic and fear, be careful. An emotion-driven action in that state will likely be in the wrong direction. Have a trusted financial advisor or a rock-solid IPS that can help “talk you off the ledge.”
Do you draw other conclusions? Have you ever acted in a panic? Have you ever been surprised when looking at old financial records? Please share a comment.