Incomplete information or understanding. Half knowledge is truly dangerous. 

This is a difficult mistake to avoid – simply because there are no clear boundaries as to what is complete information. Suffice to say, the investor must have a clear-enough understanding of the main strengths, weaknesses, opportunities, and threats (SWOT) of the business (company stock) that he/she is buying/holding. We can try to use the Pareto principle (80% of the results from 20% of the work) here to make good use of our limited time, but the more knowledge we have organised, the better. On the flip-side, there are “investors” who spend more time researching a refrigerator for their homes, than an investment security that they plan to allocate many times more money to. Even worse, if they buy on impulse based on hearsay or trusting someone blindly. Remember, no one cares about your money as much as you (should) do.

“Investing” in speculative assets such as options, forex and futures.

The word investing has been misused more times than can be counted. Just allocating money to a financial asset is not investing. Instead it is all the planning, analysis, and research that goes behind making a good, reasonable, logical decision. Such a decision has all likelihood of delivering a profit – sooner or later. Indeed, beyond just that one decision, it is creating a robust decision-making framework that comes in handy in all kinds of circumstances in the future. That said, some investment instruments simply can’t be properly evaluated to arrive at a fair value number. Derivates such as options, foreign exchange rates, and commodity futures are examples of hard-to-predict securities. In such cases, we have to realise that we are essentially gambling with our money. Yes, it can lead to big returns, but equally big losses – one can never tell with enough certainty. Our suggestion: avoid them, for a majority of your portfolio. 

Looking to short stocks

We always say that investing: “the downside (risk of loss) is limited to what you have invested, but the upside (profit) is unlimited if you give it enough time”. This is true only if you “long” the stocks i.e. you buy the asset. But there is another type of transaction where you sell the asset first, with a contract that you will buy it back sometime in the future – hopefully at a lower price. In this kind of relatively complex transaction, the opposite of our saying above is true: the downside is theoretically unlimited if the asset that you have shorted continues to rise in price indefinitely. This, in our opinion, makes it a very risky proposition. We do hear of some successful short sellers, for example, Jim Chanos with Enron in 2001, or the Michael Burry with the US housing market in 2007. But these short-sellers have also lost a lot since their successes with short trades, for example, with Tesla. Another famous short trade that went wrong in the 2010s was Bill Ackman with Herbalife. Perhaps that is why the greatest investors like Warren Buffett rarely or never get into short trades. “It’s ruined a lot of people,” the Oracle of Omaha once said. Even though he saw many more wildly overvalued companies than undervalued, making it reasonable to think it is easier to be a short seller, there are other forces at play – like what happened with GameStop in 2021 – that make short selling an unattractive risk-reward deal.