Big Mistakes

If you’ve ever thought every great investor has it perfectly figured out, think again – even legends have made disastrous errors.

1. Investment Strategies Aren’t Foolproof

Investment techniques attract attention for their apparent simplicity, but reality tends to complicate matters. Benjamin Graham, hailed as the father of value investing, argued that a company’s price can wildly differ from its actual worth, and this concept became the cornerstone of his popular method. However, even Graham, with his vast understanding, wasn’t immune to error.

Graham once watched General Electric's valuation drop dramatically without any significant changes in the company's operations or performance. The plummeting price was driven by emotional investors, not underlying value. Graham's method emphasized these discrepancies, spotlighting opportunities within undervalued companies.

Yet, when the Great Depression hit, Graham himself faltered. He believed the market's worst days were behind him and heavily reinvested in 1930, only to witness further declines until 1932. By the time the market bottomed out, his investments had lost 70% of their value. Even the best methods can't guard against human misjudgment or unpredictable markets.

Examples

• Graham's value investing revolutionized finance but didn't save him during the economic downturn.
• Emotional market reactions caused significant price fluctuations, like General Electric’s valuation plunge.
• Misjudging the Great Depression’s severity led Graham into steep losses despite his expertise.

2. Neglecting Risk Is a Recipe for Disaster

The mantra “buy low, sell high” may sound simple, yet overlooking the risks involved can lead to catastrophe. Jesse Livermore, one of Wall Street’s most celebrated speculators, soared to billion-dollar heights only to crash due to repeated risk-related missteps.

Livermore’s rollercoaster career included losing his entire fortune in early bets as a young trader. While he bounced back spectacularly, even predicting and profiting from the 1929 crash, his lack of risk management eventually led to financial ruin. Post-1929, he miscalculated a market recovery, reversing bets impulsively and compounding his losses.

His ultimate failure wasn’t due to a lack of insight but overreliance on his instincts. Despite all his knowledge, Livermore didn’t diversify or manage his risk wisely, leading to multiple bankruptcies and his tragic end.

Examples

• Livermore lost everything after betting wrong on early markets.
• His short-selling triumph during the 1929 crash masked glaring vulnerabilities in risk control.
• A misjudged market reversal after the crash caused his downfall.

3. Diversification Is Key

Relying too heavily on one investment can bring wins but poses significant threats. The Sequoia Fund, a giant investment firm, learned this lesson the hard way when Valeant Pharmaceuticals’ scandalous practices tanked its portfolio.

Sequoia purchased cheap Valeant shares in 2010, which skyrocketed in value, turning Valeant into the fund's top holding. But trouble arose when unethical practices like raising drug prices obscured real performance. Regulatory scrutiny and accusations of fraud caused the stock to plummet, wiping 90% off its value and dragging Sequoia’s assets down with it.

If Sequoia had spread their investments across industries or types of assets, they might have avoided this blow. Instead, this single misstep tarnished decades of success.

Examples

• Valeant’s inflated success initially paid off handsomely for Sequoia.
• Public backlash and Hillary Clinton’s campaign promise eroded Valeant’s stock value.
• By concentrating resources into one lucrative yet risky investment, Sequoia suffered immense losses.

4. Emotional Decisions Lead to Regret

Mark Twain, known for his masterful storytelling, dabbled in investing with disastrous results. Emotion and overexcitement clouded his judgement, leading to poorly thought-out decisions.

Twain invested considerable money in a flawed invention – the kaolotype – after being dazzled by its potential. He trusted the inventor completely and even supported him financially without clear deadlines or assurances, losing nearly $1 million by today’s standards.

Adding to the regret was the missed opportunity with Alexander Graham Bell’s telephone. Disillusioned by previous losses, Twain rejected Bell’s offer to invest even at a discounted rate. The loss wasn't financial alone but emotional, as it influenced Twain’s judgement for years.

Examples

• Twain's faith in the kaolotype invention led to near-complete financial loss.
• Fear and bitterness from prior failures prompted him to dismiss Bell’s groundbreaking invention.
• Twain’s passion-laced decisions repeatedly backfired.

5. Success Often Breeds Overconfidence

Jerry Tsai, a 1960s investment superstar, grew too confident after skyrocketing to fame. His Manhattan Fund earned immense hype, but when the markets turned, his aggressive investment style revealed its flaws.

Initially, Tsai quickly grew Fidelity Capital Fund with fast-paced trading. This success earned him celebrity status. However, the late ‘60s brought market turmoil, exposing weaknesses within his fund’s overly short-term approach.

The Manhattan Fund’s investment in National Student Marketing epitomized his misjudgment. Buying stock at $143 only to sell at $3.50 demonstrated the danger of overestimating skill during booming times.

Examples

• Tsai’s rapid-trading gains rode the 1960s’ exceptional economic tide.
• Shifting market environments rendered his style outdated during downturns.
• The Manhattan Fund suffered massive losses.

6. Overconfidence Hurts Even the Best

Even investment genius Warren Buffett isn’t invincible. His $433 million purchase of Dexter Shoe Company in 1993 became one of his costliest failures.

Buffett placed immense trust in Dexter, calling it brilliantly managed. Yet he misjudged the growing dominance of low-cost overseas manufacturers. This shift rendered Dexter uncompetitive, and by 2001 it was shut down. His mistake wasn’t just about Dexter’s decline, but overconfidence from his prior successes blinding him to changing industry trends.

Examples

• Dexter Shoe went from promising purchase to an industry casualty.
• Buffett’s prior streak led him to overlook warning signs.
• Competitors from Asia demonstrated the underestimated impact of globalization.

7. Avoid Unforced Errors

Stanley Druckenmiller’s wrong moves in 1999 exemplify how small lapses pave the way to huge failures. Known for his skills in currency trading, Druckenmiller couldn’t resist tech investments during their boom – despite being unfamiliar with the sector.

His misstep began with $200 million placed against tech stocks, believing they were overpriced. Tech rose instead, and his losses mounted. Panicking, he reversed strategies and invested in VeriSign, unwisely chasing trends. When the tech bubble burst, this decision erased half a billion dollars.

Examples

• Overconfidence led Druckenmiller to repeatedly misplay tech stocks.
• He abandoned his strength in currency trading for uncharted territories.
• His investment in VeriSign became worthless after the tech crash.

8. Big Losses Require Big Patience

Charlie Munger learned that weathering losses requires a clear mind. In 1974, he invested heavily in Blue Chip Stamps just before non-essential goods faced massive declines.

As Munger’s fund lost over 50% in value, critics grew vocal. Yet he remained undeterred by short-term loss. Blue Chip rebounded spectacularly, acquiring companies like See’s Candies and Wesco Financial. Munger’s belief in long-term growth worked when patience paid off.

Examples

• Blue Chip saw an enormous dip during the 1970s downturn.
• Munger ignored public doubts and maintained faith in his choice.
• The bet turned into long-term monetary and strategic success down the line.

9. Don’t Sell During a Panic

Amazon’s stock success reflects the importance of resisting impulsive actions. While holding an early investment could bring wealth today, Amazon’s price halved multiple times over its history. Many sold during these losses, missing out on its longer-term prosperity.

This lesson applies to all investment types. Large companies often face temporary setbacks. The ability to hold through turbulent times, rather than panic selling, distinguishes successful investors.

Examples

• Amazon shares fell dramatically three times, testing investors’ convictions.
• Investors who held on through drops reaped significant rewards.
• Panicked selling during downturns often locks in losses unnecessarily.

Takeaways

1. Research companies thoroughly rather than chasing trends, and stick to your expertise.
2. Diversify investments to minimize the impact of isolated mistakes.
3. Stay calm after losses, and focus on long-term goals rather than reacting to temporary dips.