There’s nothing sexy about mistakes. No one wants to admit to them and everyone wants to gloss over them, push them to the part of the brain that forgets things for us. Why focus on something that is painful? I’ll tell you something for nothing, acknowledging and rectifying past mistakes will lead to more profits than ignoring them. The aim of this article is to hopefully make you aware of the obvious mistakes that might or might not be plaguing your investment returns and hopefully inspiring you, and your adviser, to get proactive.

Disclaimer: Hand firmly in the air, at some point in time or another, I’ve succumb to these mistakes.

Overestimating your circle of competence

Warren Buffett, arguably the world’s greatest investor who built a $US60 billion fortune by investing in the stock market, frequently professes to “never overestimate your circle of competence”. If he didn’t understand a particular business, he simply didn’t invest in it, no matter how bright its prospects sounded. Despite sharing a close friendship for over two decades with fellow billionaire Bill Gates, founder of Microsoft, Buffett never bought a single Microsoft share…he simply didn’t understand the business economics of software development.

When investing in the stock market, or any asset for that matter, quickly ascertaining what makes sense to you and what doesn’t is of upmost importance. I have many clients who steer clear of companies operating in the resources sector. They have no background in geology or drilling (neither do I) and the annual reports of those companies might as well be in Dutch. The retail industry, however, is a much easier game to comprehend and follow. Let’s take JB Hi-Fi (ASX:JBH) as an example. Revenue is derived from selling goods, such as TV’s, DVD’s and other electronic devices to the general public. Costs include rent, cost of sales (what they pay the wholesaler), wages and promotion/marketing expenditure. Minus these costs from revenue, and hopefully you have a profit left over for shareholders. Stick to what you know but be open to learning new things. Your aim, at the end of the day, is expanding your circle of competence, and then investing accordingly.

Overconfidence

Overconfidence varies from thinking you know more than you do. There is a saying in football, ‘things are never as good as they seem and never as bad as they seem’. (As a fanatical Carlton supporter, I’m finding solace in the second component of that phrase). Humans, more specifically investors, need to be cognizant of the fact that by nature, we are overconfident in our decision making skills. I learnt the hard way that overconfidence can be very costly. Allow me to self-indulge for a moment.

Fair to say I’ve been lucky when it comes to investing in the stock market. I became interested and later passionate in an asset class (equities) in 2003, just before one of the greatest bull markets of all time. With over 80 per cent of stocks rising in value between 2004 and 2007, one could easily be placed in a false sense of security. I had to constantly remind myself that it wasn’t billionaire hedge fund manager George Soros looking back at me in the mirror.
Once I became accredited to manage other people’s capital and had that responsibility bestowed upon me, I thought it would worthwhile to look back at my previous trades whilst I was a university student to identify any obvious trends in my decision making. The one thing that stood out like Daisy Thomas in a Carlton jumper was a losing trade straight after a reasonable profitable trade. Simply put, I kept getting ahead of myself (drinking my own bathwater, as they say in footy circles) straight after a decent win and thought it would just happen for me in the next transaction, without the proper due diligence undertaken. As Alan Joyce once told Robert DiPierdomenico, “Son, you’re a much better player when you don’t think you are”. It’s a quote I constantly replay in my mind whenever I sit at the desk.

Differentiating between investing and speculating

No, it’s not much of a muchness. Thinking you’ve made an intelligent investment, when really, all you’ve done is take a punt, is a major reason why money is lost when investing in the stock market. Benjamin Graham, a chap from the 1930’s that revolutionised the way we analyse the well-being of a company, said, “An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.” Unfortunately these days, the term “investor” is being applied ubiquitously to anyone and everyone who participates in the stock market. Let’s not kid ourselves here. Unless you, or your stockbroker, have read the company updates, research, analysis etc. and understand what the company stands for, then you’re punting on that particular company performing to your expectations.

If you have the stomach for it, speculating with a small percentage of your overall capital in a company that you’re hoping will turn into a 10 bagger makes sense. However, that’s not an investment. Investment is an educated assessment of value, and you can only value a company when it makes profits, not promises.

Take a look at your holdings along with your stockbroker and he honest with yourself – which one are investments and which are punts? You’ll be surprised.

*Sam Fimis is a stockbroker with Patersons Securities and author of Premiership Portfolio: 6 Step Guide to Succeeding in the Stock Market. For more information, visit www.premiershipportfolio.com