It turns out, it's really easy to lose a lot of money really fast in the stock market. I'm living proof but I could have quit and been like everyone else, instead I doubled down, fought back and eventually started to win.
Let me take you back to where this all started, 2001 - a much simpler time when making millions in the stock market simply required a trading account and buying anything that ended in a .com. 2001 was the winding down to a turbulent and volatile market, a bubble so large that it brought in many new investors and destroy many great companies.
I was 17, but I wanted to get in. I was sure I could do better than my parents financial advisor - I was young, naive and passionate. With the help of my parents I opened up my first trading account, a web trader account at TD Waterhouse. I had just transferred in all the money my parents had saved for me that wasn't needed for university, a whole $5,000, which could have been a million dollars to me, it was a lot of money.
I remember the day that the money arrived, I was staring at the white screen of my brokerage account, where to put my money. First I went into mutual funds, boring, I was out in a few weeks for more interesting trades in bank stocks and then into the world of small caps. This is where the fun was and I didn't know it yet, but the extreme pain that can be investing.
I fell in love with small caps, because it felt like I was finding an uncut diamond that no one had seen. Each one was going to be the next Microsoft, Google or Facebook in my mind, but in reality they all turned out to be another version of Enron, just dressed up differently. Over the next few years, I had somehow built up huge positions across multiple accounts to about $100,000 in small caps and even micro caps. I thought I was an investing genius, that I could do no wrong, until these companies one by one started to drop fast and in some cases go bankrupt as we rolled into our next recession, the "great housing crisis".
Right as the housing crisis was exploding in 2007, I was finishing university and my losses totalled more than $75,000 - I was a complete wreck. This was supposed to be a great time, but all I could think about was the $75,000 I lost and what it could buy for me. I was 22 years old, had about $30,000 in student debt and I had just lost more money than most people make in a year. How in the world could I be so wrong? How could I lose so much money?
In hindsight, this was the best thing that could ever happen to me. I started to realize that I had been playing the hardest game in the world, investing. It's so hard because the people you are up against are the smartest and strongest with the best tools and they've been doing it for a very long time. If I was going to win at this game, I had to play by a different set of rules. In investing there has always been this constant: Great companies will always win and mediocre companies will continue to lose, or Warren Buffett and Charlie Munger have put it best, "It is better to buy a great company at a fair price, than a fair company at a great price." It took me many years to really understand what they meant by this, but today it is as clear as day!
See what I had been doing previously investing in small caps was gambling, these weren't great companies, they just had momentum. I made the investing mistake of telling myself that I was this great investor, even as the losses piled up. It didn't feel like gambling because I didn't have a drink in my hand, but it was; I was playing small-cap roulette.
Luckily 2008 came along and wiped me out completely, forced me to rethink my whole approach and I did what almost every investor before me has done after losing; I quit. I put all my energy into my first job and lost my love for investing. It was clear to me at that moment that I didn't know anything about investing, I was a failure, time to move on and leave investing to the professionals. I sold every last stock and avoided any conversations about investing.
Within a few months I was back, I loved investing and the book that brought me back was Joel Greenblatt's book, "The Little Book That Beats The Markets". I had made mistakes on the wrong stocks to own and extreme emotional trading, but the formula in the book called, "The Magic Investing Formula" solved all those problems. I didn't have to pick stocks, there was a formula that automatically gave them to me, it told me when to sell and it was a big enough portfolio that no single mistake could kill my portfolio. I had to test out this concept, so I set up a fantasy portfolio just to see how it would work, because you have to understand at this point, I had zero confidence in my investing abilities.
I followed the rules of the book and put together a portfolio of 30 stocks in December 2008. One year later in December 2009, that portfolio increased 75% which destroyed the S&P 500, which was an insane return. Over the next 6 years, this portfolio would return more than 30% per year.
I was back in, all the mistakes I had previously made were being solved by this "Magic Formula" it was autopilot investing and a strategy that could work for the long-term. It was 8 years since I had started investing and I was now finally starting to understand how to invest properly.
From 2009-2014 I used the strategy to fantastic returns, but I started to tweak it a bit. During this time I read more business and investing books, I read blogs, I read WSJ and Barrons and Fortune and Forbes and HBR and annual reports and CNBC and everything I could get my hands on. I then found a resource that would completely change my investing approach yet again, Morningstar's Stock research (full review coming shortly). In 2015 I moved away from the very technical approach of the Magic Investing Formula (it taught me a lot, but it was time to move on) and moved to a hybrid model of Buffett, Morningstar, Value, Growth and Great Companies - this was now my style. I would not be in the place that I am today without the mistakes of the past, so let's talk about what I learned.
Have An Investing Plan
You see traders on TV or in movies, on CNBC who say things like, "My gut is telling me to hold until 25 and then sell," what kind of advice is that? How is that in anyway actionable? How the hell I am to build that into my investing plan?
"The Magic Investing Formula" taught me a really important lesson. It was to buy on a specific day every quarter or every 6 months or every year. Because a stock is up or down doesn't mean it should be traded.
Today I continue to follow those rules and only trade on the 15th (or closest if it falls on a weekend) of every March, June, September and December of each year. Mostly I buy and do very little selling, but there are two exceptions to the rule, if the company gets bought out I sell and if the company has had some significant changes that would force me to no longer be a shareholder. Luckily the second one hasn't happened to me yet, but I'm sure it will eventually.
Buy Great Companies and Avoid Good/OK/Bad Ones
This may sound intuitive, but believe me this is a super advanced concept that I will explore in a future post. How can you tell if a company is truly great versus merely good? This takes a keen study of business and an understanding of competitive advantages and we can still be wrong about it. A great resource to start helping you with this is Morningstar's Stock Analysis. Morningstar is not always right, but what they can help you do is understand a company's core competitive advantage. It is up to you to determine if that's the kind of advantage that can last.
Today the companies I own in my portfolio, I will likely hold for many years, either these companies are the best in the industry or will soon be the best in the industry. Many of them are fast growing and building stronger and stronger competitive advantages in their respective industries/niches.
Whatever Happens To The Stock, Just Do Nothing!
Not exactly a great slogan for anything, but this is a common strategy of the best investors in the world. Again, this sounds like a simple and easy thing to do, but it is anything but. Imagine one of those great companies we are talking about one day just decides to tank for no good reason. Maybe they had a bad quarter or some bad news came out, but doesn't really affect the long-term value of the company and the stock is down 30%, you start to question yourself. Did I do something wrong? Did I value the company correctly? What do people know that I don't?
Great companies always bounce back, sometimes it happens fast and other times it is brutally slow, but it always happens. The only time this doesn't happen is when you are wrong and the company you own was not truly great (more on this in a future post). However, in situations where we own great companies, the only thing you should do is nothing. Don't trade, don't sell or some trader will take advantage of you. Just sit there, go read a book, go to a movie, go drinking with your friends, take a trip, but do anything except sell your shares.
It is so easy to get caught up in the bad investing game, we're human, we want to run away from loss, not towards it; this is how we survive the ages, but this doesn't work in the investing game.