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Investing is easy - if you lie to yourself Add to ...

Fabrice Taylor is a chartered financial analyst.

It's Christmas party season, which means lots of standing around in kitchens surrounded by people looking for stock tips. Over the years I've noticed something curious about us retail investors: We're all brilliant. None of us ever loses money; we all make healthy returns over time.

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It's not true, or course. Most retail investors lose money, and if not, they don't keep up with the index. Investing is hard. One of the hardest parts is not falling for the sad tricks you can play on yourself in your mental accounting.

You know what I mean: That tendency to tell yourself that you'd be doing great if you had just ignored that one bomb. "I'd be up 14 per cent if I hadn't bought General Electric for $40 and sold it for $6."

If a company tried to tell investors it was profitable except for that huge loss, there'd be a lawsuit, yet we all do it to ourselves, let's be honest. And here's how the math works out: If you make 12 per cent one year, then 14, then 17, you're up 50 per cent after three years, which is excellent. But if you get drunk on success and forget that stocks also go down and lose 40 per cent, you're suddenly down. You've lost every cent you made and a 10th of your principal.

Here's where it really hurts: You have to make 21 points in the next year just to get back to zero in real terms, i.e. to be flat including inflation (I used 2 per cent for the rate incidentally). Sadly, your simple average return is less than 1 per cent. Good luck with that.

So it's easy to see why our minds try to protect us from this misery. It's also easy to see why avoiding losses is quite literally more important than making money in the stock market. Losses are very difficult to recover from, yet they don't seem insurmountable unless you really think about it in the cold sober light of day.

As to how to avoid losses, that's pretty straightforward, and it's not just about sticking to quality. Some of the biggest blowups in the market in the past year were blue chips, such as General Electric.

The answer is stick to what you know and understand. Barrick Gold's annual report is 154 pages, much of it inscrutable. Wesdome Gold Mines, a Vox favourite and up 145 per cent since we recommended it 10 months ago, gives you 34 pages of reading (disclosure: I own the debentures). Leon's Furniture's annual report is also 34 pages. Bank of Montreal's is 158 pages. It's not just size of course, it's how understandable it is. But generally, there's a correlation between size and ease of use.

As for the fact that there aren't too many easy-to-understand companies worth investing in, that's the grim reality of the stock market. If they were all great companies, they wouldn't need money from other investors would they?

This is useful to think about if you're shopping for someone to manage your money. The truth is that there aren't that many really good professional money managers in this country.

Even some of the publicity-shy investors with great long-term records have recently had fatal blowups.

But there are a few - they tend to get next to no publicity because they don't want it - and I can assure you that the most striking thing about their returns is not that they're eye-popping. It's that they're consistent. Eye-popping returns tend to be associated with blowups.

They avoid blowing up and they don't think they're brilliant because they're on a run. They know better than that.

 

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