The seven deadly investment sins

Sin #1: Believing you need to predict the market’s next move to make big returns.

Reality: Highly successful investors are no better at predicting the market’s next move than you or I. One month before the October 1987 stock market crash, George Soros told Forbes magazine and the Financial Times he felt that there was a crash coming in Japan. One week later, Soros’s Quantum Fund lost over $350m as the US market - not the Japanese market - crashed. As Soros admits: “My financial success stands in stark contrast with my ability to forecast events.” And Buffett? He simply doesn’t care about what the market might do next. To him, “forecasts may tell you a great deal about the forecaster; they tell you nothing about the future.”

Sin #2: The Guru Belief. Believing there is a “guru” out there who can  predict the market.

Reality: If you could predict the future, would you shout about it from the rooftops or would you keep your mouth shut, open a brokerage account and make a pile of money? Elaine Garzarelli was an obscure number-cruncher when, in 1987, she predicted “an imminent collapse in the stock market”. That was just one week before October’s ‘Black Monday’. Suddenly, she became a media celebrity. This guru status made Elaine Garzarelli plenty of money - but not her followers. Media ‘gurus’ make their money from talking about investments, selling their advice or charging fees to manage other people’s money. But, as John Train put it in The Midas Touch: “The man who discovers how to turn lead into gold isn’t going to give you the secret for $100 a year.” That’s why master investors rarely talk about what they’re doing.

Sin #3: Believing that ‘inside information’ is the way to make really big money.

Reality: Warren Buffett is the world’s richest investor. His favorite source of investment ‘tips’ is usually free for the asking through company annual reports. George Soros earned the title of ‘The Man Who Broke the Bank of England’ when he took a massive $10bn short position against the pound sterling in 1992. He wasn’t alone. Hundreds, if not thousands of other traders also cleaned up when the pound plummeted. But only Soros jumped in with both feet and took home $2bn in profits. Now that they are famous, Buffett and Soros have ready access to highly placed people. But when they began investing, they were nobodies, and could expect no special welcome. What’s more, both Buffett’s and Soros’ investment returns were higher then, when they were unknown, than they are today. As Buffett says: “With enough inside information and $1m you can go broke in a year.”

Sin #4: Diversifying.

Reality: Buffet’s amazing track record comes from identifying half a dozen great companies – and then taking huge positions in only those companies. According to Soros, what’s important is not whether you’re right or wrong about the market. What’s important is how much money you make when you’re right about a trade, and how much money you lose when you’re wrong. The source of Soros’s success is exactly the same as Buffett’s: a handful of positions that produce huge profits that more than offset losses on other investments. Diversification is the exact opposite: having many small holdings assures that even a spectacular profit in one of them will make little difference to your total wealth. Highly successful investors will all tell you that diversification is for the birds.

Sin #5:  Believing that you have to take big risks to make big profits.

Reality: Just as successful entrepreneurs are risk-averse, so are successful investors. Avoiding risk is fundamental to accumulating wealth. Contrary to the academic myth, if you take big risks you’re more likely to end up making big losses than banking giant profits. Like entrepreneurs, successful investors know it’s easier to lose money than it is to make it. That’s why they pay more attention to avoiding losses than to chasing profits.

Sin #6: The “System” belief. Somebody, somewhere has developed a system that will guarantee investment profits.

Reality: This is a corollary of the “Guru” belief – if an investor can just get his hands on a guru’s system, he’ll be able to make as much money as the guru says he does. The widespread susceptibility to this deadly investment sin is why people selling commodity trading systems can make good money. The root of the “Guru” and “System” beliefs is the same: the desire for a sure thing. As Buffett responded to a question about one of the books written about him: “People are looking for a formula.” The hope that by finding the right formula, all they’ll have to do is plug it in to the computer and watch the money pour out.

Sin #7: Believing that you know what the future will bring – and being certain that the market must inevitably prove you right.

Reality: This belief is a regular feature of investment manias. Virtually everyone agreed with Irving Fisher when he proclaimed: “Stocks have reached a new, permanently high plateau”, just a few weeks before the stock market crash of 1929. This is a more powerful variant of the first deadly sin - that you have to be able to predict the future – but far more tragic. The investor who believes he must be able to predict the future to make money searches for the right predictive method. The investor who falls under the spell of the seventh deadly investment sin thinks he already knows what the future will bring. So when the mania eventually comes to its end, he loses most of his capital – and sometimes his house and his shirt as well. Of all the seven deadly investment sins, coming to the market with a dogmatic belief is by far the most hazardous to your wealth.

Extracts taken from ‘The Winning Investment Habits of Warren Buffett & George Soros: What You Can Learn From the World’s Richest Investors’ by Mark Tier.