‘He’s lost the lot’
What do you mean, he’s lost the lot?’
The whole $11m…gone.’
Are you serious?’
Deadly serious. He’s in a bad way.’
How did it happen?’
He got talked into a deal and it all went pear shaped.’
Why did he risk the lot?’
Thought it was a sure thing.’
This was a conversation I had recently with a friend who called me about a mutual acquaintance…we’ll call him Tom.
Tom was a successful businessman. After working hard for 25 years he sold his business. The capital realisation moment that most business people dream of. The net proceeds from the sale was around $11 million.
Wealth comes with two phases — creation and retention.
Tom created wealth but he didn’t have the skill set to retain it.
This is a common affliction with lotto winners. Gaining wealth is one thing, keeping is a whole different ball game.
There are so many people out there who want to part you from your money. Some are well meaning and do this unintentionally. Others are outright vultures looking for a target.
Tom fell victim to the latter. He was groomed with promises of doubling and even tripling his investment. Apparently it all looked good on paper.
The vulture had all the ‘know-how’ and ‘contacts’ but it was Tom and a couple of others who had the money. I won’t tell you the scheme details as it’s been in the local press and I don’t want to embarrass Tom.
Tom still owns his home and has funds in superannuation, but this is small change compared to the $11 million that’s been vaporised.
One mistake flushed 25-years of work down the drain. And it was avoidable.
Focussing on reward is an investor’s greatest folly.
Successful investors work out what the risk is and once that has been determined they calculate whether the potential reward warrants the risk.
Tom looked at the double and tripling of capital and I imagine he had stars in his eyes about the lifestyle that would come with having $30 million. Instead he should have focussed on what sort of lifestyle he’d have if he lost the lot.
Unfortunately, now he knows.
According to my friend, Tom is shattered. His wife is devastated and Tom’s guilt levels are on the far right of the scale.
Creating wealth has its challenges but retention of wealth is an even bigger challenge. The stakes are much higher.
In the 8 May 2014 edition of my Family Wealth advisory letter, I wrote about the benefits of a dull and boring investment approach and warned about charismatic salespeople.
I’d like to share that article with you today in the hope you don’t suffer the same fate as Tom.
Centuries of investor folly
‘The big money is not in the buying or the selling, but in the sitting.’
US share investor, Jesse Livermore (1877–1940)
In 1929 Livermore amassed a $100 million fortune from short-selling the market crash. During his investing career Livermore developed his own rules for successful investing. Unfortunately he did not always follow them — perhaps his lifelong battle with depression influenced his normally disciplined investment approach. Whatever the reasons, Livermore managed to lose the majority of his fortune during the 1930′s and committed suicide in 1940.
Livermore’s ability to make money inspired Richard Smitten to write two books; Jesse Livermore: The World’s Greatest Stock Trader published in 2001, and Trade like Jesse Livermore in 2004.
One of Livermore’s favourite books was Extraordinary Popular Delusions and the Madness of Crowds written by Charles Mackay in 1841.
Michael Lewis (of Flash Boys fame) is also a fan of Mackay’s book — especially the chapters dealing with economic bubbles. Although the book was written 170 years ago, Mackay had plenty of reference material to draw on — the 1637 Dutch Tulip Mania; the 1711–1720 South Sea Company bubble and the 1719–1720 Missouri Company bubble.
Nothing is new in the investing world. The booms and busts we are experiencing have, over the centuries, all been played out many times before. Expansion followed by contraction — simple physics.
The subjects of greed and fear — tulips, railway stocks, land rushes, tech stocks, housing markets, etc. — change, but the emotions don’t. The herd reacts in a predictable fashion.
Source: Kevin Kallaugher, Economist
When I approached Port Phillip Publishing regarding the Family Wealth project, my main reservation was the dullness of the strategy — would people actually pay to be patient? Centuries of investor folly are a clear indicator we are not wired for ‘boring’. The only time investors seem prepared to sit is when they contemplate ‘how could I have been so stupid?’
A simple, dull and thoroughly mundane investment strategy tends to appeal to someone who has asked himself or herself this question on more than one occasion. Nearly three decades in the investment business has taught me how valuable and rewarding boring really is.
Naturally this steady approach runs counter to our primal instincts of fight or flight. Therefore it is important to know our limitations (in the scheme of things the majority of us are not that smart when it comes to investing) and invest accordingly.
Successful short term investing can be both skill and luck. Successful long term investing is skill and discipline.
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The psychology of winners and loser
Understanding, or at least appreciating, the game that goes on between our ears is crucial to improving the odds of us being classified as ‘successful long term investors’.
Our thought processes control our emotions and actions — just ask James Packer and David Gyngell.
Here are a couple of psychological conditions that relate to investing:
- Metacognition: The less competent you are at a task, the more likely you are to overestimate your ability to accomplish it well. Competence in a given field actually weakens self-confidence.
- Dunning Kruger Effect: Dunning Kruger is a cognitive bias in which unskilled people make poor decisions and reach erroneous conclusions, but their incompetence denies them the metacognitive ability to recognise these mistakes.
Starting my career in financial planning in 1986 (with negligible investment experience) I felt the pressure to ‘know it all’ and if I didn’t, then clients would perceive me as incompetent. A classic case of metacognition.
Years of being ‘chewed up and spat out’ by the market has taught me a great deal about humility and my own limitations. On balance these experiences (I feel) have made me more competent and definitely more wary (weaken self-confidence).
In 1984, Bennett W. Goodspeed wrote The Tao Jones Averages: A Guide to Whole-Brained Investing.
The Tao reference in the title relates to the Taoist philosophy of ‘balance’.
A topic Goodspeed discussed was the power of ‘The articulate incompetent’ to influence public thinking. (There are a few politicians that fit this category.)
Goodspeed identified the following characteristics of the ‘articulate incompetents’ in the investing world:
- The more self-confident an expert appears, the more likely TV viewers will believe them, but the worse their track record is likely to be.
- So-called expert forecasters do no better than the average member of the public.
- Forecasters who predict a single outlier correctly are more likely to underperform the rest of the time.
- Experts who acknowledge the future is inherently unknowable and unpredictable are perceived as being uncertain and ironically, less trustworthy.
The take-away from these observations is the majority want to be led, even if the charismatic but useless leader is taking them down the road to ruin.
People do not want qualified caution and definitely want no part of boring.
The investment industry knows investor psychology better than anyone, which is precisely why they design the products they do.
I wish I had of sent this article to Tom, perhaps it might have made a difference. My guess is it probably wouldn’t have.
Sometimes you can tell people till you are ‘blue in the face’ about investment risks, but most people (especially males) over-estimate their ability and think it won’t happen to them…particularly if they’ve been successful in another endeavour.
Sadly history is replete with stories like Tom’s and I have no doubt that the future holds similar hard luck stories for investors.
Hopefully after reading this you successfully manage to not only create wealth, but also retain and progressively increase your wealth.
Think a lot and act a little.
Editor, The Daily Reckoning