Why should you make a list of your mistakes? In the investment business, you must expect to be wrong. This ritual forces you to stop lying to yourself about what a great investor you are.
In most fields, if you get 3 out of 5 things wrong, your career is in deep trouble. Imagine if a doctor had 60 percent of clients die on him, or an accountant with a 60 percent audit rate.
Investing is more comparable to baseball, where hitting the ball only two out of five times means you are batting .400 — making you one of the greatest batters of all time. (Congratulations — you are Ted Williams!)
Understanding this strikeout ratio is just a small part of successful investing. It also helps to have a plan in place so you know what to do when you whiff.
I am frequently — and, on occasion, spectacularly — wrong. But I expect that to be the case. Pretending to divine what stocks will go up or down or where the market will be in three or six months is not only silly, it’s also counterproductive. Instead, I suggest you anticipate errors and be prepared to correct them, quickly.
Hence, my goal every year is to make a whole new set of errors, rather than repeating the same mistakes over and over again. On that note, here’s how I fared in 2013:
1 Tactical moves: Last year, a few of my tactical moves worked out, but more than a few did not. Even when you are right, there are costs and taxes associated with being tactical. When you are wrong, there are opportunity costs. At times, I carried excess cash, and that was a drag on performance.
Solution: The goal in executing tactical moves should not involve trying to sidestep the 10 to 15 percent retracements. Instead, aim to avoid the large crashes — those 25 percent-plus moves to the downside. We can reduce frequent tactical moves by tightening the metrics that feed our decision-making. Ideally, a defensive tactical investment should be deployed sparingly — twice per decade would be a lot. It should not be an annual event.
2 Real estate/housing market: I doubted — and continue to doubt — the housing market recovery. I expected more foreclosures, more underwater-owner walkaways and an even bigger bank-owned real estate overhang to weigh on the market.
I was wrong.
Instead, the market stabilized, and prices rose. I failed to recognize just how powerful the Fed’s mortgage purchasing program, Operation Twist, was. Today, you can get a 30-year fixed mortgage for about 3.5 percent. This has increased the buying power of those in the market. And the various multibillion-dollar mortgage settlements have given banks more flexibility in how they handle all of the property that remains on their books. I also overlooked the impact of $25 billion in private-equity investment in homes.
Solution: Be aware of the inorganic nature of this improvement, but do not underestimate the ability of the central bank to stabilize a housing market. After a 35 percent fall, the downside might be somewhat more limited.
3 JPMorgan: I have been critical of the too-big-to-fail banks that have opaque balance sheets. The trouble arises when we try to own a balanced portfolio with a proportional amount of exposure to the financial markets. One solution was to own companies with cleaner balance sheets and less credit risk — firms such as Visa and Berkshire Hathaway. The “Fortress Bank” that Jamie Dimon created suckered me in. Less than a year later, the London Whale lost all of my profits in the position. And then some.
Solution: Have more courage of your convictions. If you think too-big-to-fail banks are not worthy of investment because of their impossible-to-read balance sheets, well, then don’t buy them. There are lots of alternatives to get financial-sector exposure, including small-cap funds and regional banks. Be aware of the trend, but do not accede to the crowd.
4 Facebook: After berating Facebook for the better part of two years on valuation, fabricated metrics and a weak business model, I began to wonder if I was suffering my own confirmation bias — perhaps I was simply looking for information that backed up what I already thought. Self-doubts led me, as the stock came in on the day of the IPO, to buy Facebook for aggressive portfolios. Our stop-loss discipline prevented us from taking much of a loss on it — it was sold before the day ended as it traded down to the IPO price.
Solution: Again, this requires the courage of your convictions. I owned Facebook for less than a day. It never should have been bought until it neared my valuation of $25 billion (about $13 to $16 a share). If, occasionally, you have to miss a party where everyone else is having fun, so be it.
5 Global macro: One error I made this year was allowing macro views to trump our more pedestrian day-to-day investing approach. We all love to look at the really big picture, but in three of four years, it has not been a good way to make money. While global macro often works out well at major turning points, the rest of the time it has the potential to create excess activity and mischief.
Solution: Asset allocation has proven itself over time. Avoid becoming distracted by noise.
Those are the big ones for last year. Be proud of your errors. If you are not making any mistakes, you are being excessively risk-averse. Investing involves risk, and that means you will occasionally be wrong. And although it is okay to be wrong, it is not okay to stay wrong.
Come back in 12 months for a whole new set of mistakes.
Ritholtz is chief executive of FusionIQ, a quantitative research firm. He is the author of “Bailout Nation” and runs a finance blog, the Big Picture. On Twitter: @Ritholtz.