When I look back at the way I thought during my first several years of investing, I realize that my thinking is very different now. I started out too conservatively and quickly evolved to looking for big wins. Now I seek good returns while avoiding big mistakes. That’s not to say that I’m now scared of volatility. I go for the best returns I can get with the constraint that I try to keep the odds low that I’ll permanently lose a significant amount of my capital.
To illustrate what I mean, I’ll go through some examples of ways to lose capital and examine how my thinking has changed.
Any individual stock can drop 90% or more
Over the years I’ve owned several stocks that have dropped 90% or more. Before this happened to me, I didn’t think about this possibility. I once owned a stock that grew to well over half my net worth. Fortunately, I sold most of it before it dropped by more than 98% at the end of the tech boom of the late 1990s. With different timing, I could have lost almost everything.
Today I would never do anything so reckless. I choose to own many thousand of stocks worldwide through index ETFs. There are other ways to get adequate diversification, but this is my choice.
The entire stock market can drop 40% or more in just a few months
This is what happened in the stock crash of 2008-2009. The stock markets in Canada and the U.S. have always rebounded eventually from such crashes, but that doesn’t help if you’re forced to sell. I didn’t use to worry about losing my job or the leverage I had with my mortgage and possibly being forced to sell stocks low.
Now, whenever my thoughts drift to borrowing to invest more in the stock market, I remind myself of what could have happened if I had been leveraged in 2008. The losses would have been devastating. So, I stick to having no debt, I have a modest cash cushion, and I won’t invest money in stocks unless I believe I won’t need the money for at least 5 years.
During my early forays into mutual funds through advisors, I didn’t know about MERs and other costs. Even as I began to learn about these costs, I didn’t appreciate that these small percentages add up to big money. Costs can easily consume half your savings over a lifetime of investing. Even as I moved to choosing my own stocks, I didn’t appreciate how expensive currency exchange could be. Today I keep my costs very low, and I use Norbert’s Gambit to save money on currency exchange.
GICs give poor returns over the long term
I invested my first RRSP contribution in GICs. At the time, I expected to keep all my savings in GICs indefinitely. I didn’t think of myself as the sort of person who could succeed in the stock market. I later went through a phase of overconfidence.
Now I realize how easy it is to beat GICs over the long run with buy-and-hold low-cost indexing. GICs are great when you need the money in the short-term, but if I had stuck to GICs, I’d only have a fraction of my current savings.
Analyzing stocks takes a lot of time
This is more about loss of time than loss of money, but both are important. I used to believe I could pick above-average stocks and had convinced myself that I enjoyed all the work. But the truth is that I can’t get an edge on professional investors, and I enjoyed the idea of making more money and not the actual process of combing through the details of dozens of annual reports. I haven’t studied a stock in detail in years and I don’t miss it.
Overall, I’m better off avoiding both overconfidence and being overly cautious. To get rewarded we must take some risk, but we have to be careful to avoid big mistakes.