Everyone is a Genius.
During my years playing tens of thousands of hands of online poker I learned a very important lesson. Variance is a cruel, cruel mistress. If you play enough poker you’ll experience days, weeks, even months where you can do no wrong. You hit every straight or flush you’re drawing for, your pocket aces never get cracked and you make money hand over fist every time you sit down at the table. Many players confuse these hot streaks with their incredible edge in skill over their opponents. They take their newly flush bankrolls, sit down in bigger (read: more expensive) games and more often than not…they get crushed.
The mistake these players make is overrating their skill level based on being on the right side of statistical variance. They forget that right around the corner, somewhere, at some point, they’re going to be sitting on the other end of that variance and if they’re not careful it will wipe them out.
“Cool story, Jay…but what’s this got to do with investing?”
A lot, actually. In a bull market like the one we’ve experienced over the last few years everyone thinks they’re an investing genius. Buy a stock and watch it go up! Its easy!
Like with those poker players who confused a good run with superior skill, many investors are now doing the same. Greed is back in a big way. Every day it seems I’m reading another article about trying to unearth the next big multibagger stock. No longer are investors content with sitting back and earning market matching returns. Now is the time to take chances and get rich by crushing the market!
The only problem with that idea is that it will probably end very badly for you. Somewhere around the corner is another recession just waiting to crush unsuspecting investors. It is coming, we’re just getting some of that positive variance right now. These double digit positive returns aren’t the “new normal” just like those 600 point drops we saw during the financial crisis weren’t.
You can’t accurately assess your skill in anything when everything is going your way. Any idiot can pick winning stocks in a bull market, just like any idiot can ride a wave of good cards to a winning night at the poker table. The best poker players are the ones that lose the least or even find ways to eek out wins during the stretches where it seems everything is going against them. Just like the best investors can deliver results in bull and bear markets.
The reason I’m going into all this is because I want to tell you something about yourself, and I want to make sure you can handle it…
You’re not good at picking stocks.
Take a minute, let that sink in… still with me? Ok…
Investors are a lot like fishermen. Find a fisherman and they’ll talk all day about the one time they hooked that 1000lb marlin. But you never seem to hear stories about all the tiny trout they catch, and certainly not about the days they came home with no fish at all! Just like investors will tell incessant stories about how they invested in Apple at $100/share or they got into Amazon.com back in 1999. But you’ll never seem to meet anyone that lost money by investing in Pets.com or the Facebook IPO.
I could write an entire post patting my back for the 700% returns I made on Sirius and XM back in the early days of satellite radio. Or even more recently how I bought into Ingersoll Rand at $12 per share and 3M at $35. You’d think I was an amazing investor, but what I wouldn’t tell you about is all the money I lost on Bank of America, Agilent Technologies and Royal Bank of Scotland.
Very few investors can outperform the market over an extended period of time. Warren Buffett is so confident in this fact that he made a $1,000,000 bet with any fund manager who thought they could outperform the S&P 500 over a 10 year period. (A bet he’s currently winning). The fact is that the vast majority of fund managers can’t beat the index on a consistent basis, so what makes you think that you can?
My point in all this is that you shouldn’t get carried away by the returns you’ve seen lately and throw away your asset allocation strategy in the name of swinging for the fences.
Investing in individual stocks and even searching for the next Google has its place, but the reason we come up with an asset allocation is to ensure ourselves steady returns in good markets as well as in bad. Right now the U.S. housing and stock market is on fire while Europe, Asia and Emerging Markets are struggling. It’s going to be really tempting to abandon your investments in those struggling areas to chase the high returns in the US markets. By doing so you’ll be consolidating your risk into one area and will be hung out to dry when the cards start to turn against you. The right move is to rebalance your holdings to fall in line with your asset allocation and remember not to let greed distract you from your goals.
Readers: Have you changed your investing focus in the recent market? Have you found yourself taking on more risk and investing in speculative stocks?
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