Mistakes were Made. (And, Yes, by Me.)

It’s part of human nature to want to be right. It informs our view of our self, and, especially if we take a public stand, we commit to it much more strongly than we would otherwise. In his excellent book, Influence: The Psychology of Persuasion, Robert B. Cialdini devotes an entire chapter to it—Commitment and Consistency. Once we commit to something and take a stand, we are loath to change our minds, even in light of new information that contradicts our stance. Of course, this sometimes leads to huge mistakes, and is often the reason our investments go awry. We hate cogitative dissonance and will usually do anything to hang on to our stated positions, even when, especially when, they are wrong.

I thought it would be an interesting exercise to look at all the times where I got it almost entirely wrong, not for self-abasement, but rather as an exercise in how we can learn from our mistakes and still go on to do very well in life and our chosen careers. Thus, in no particular order, let’s look at things I got wrong, and what I learned:

1.     An early faith that no-load funds would destroy those offered by financial advisors for a fee lead me to miss a huge opportunity.

In the mid-1990s, I had a relationship with one of the biggest brokerage houses in the United States, and after the initial publication of my book, What Works on Wall Street, my firm was enjoying a lot of interest from investors. We decided to open a mutual fund family, and one of my colleagues at the brokerage house suggested that I open load funds, so that their army of advisors could offer them to the public. The advisors at the firm were already offering another portfolio of mine and everyone I talked to brokerage thought that this was an easy decision. It would have allowed my firm to take huge advantage of the momentum we were having in other areas of our business and give the brokerage firm’s advisors access to what were among the first factor-based funds. I declined.

My unwavering belief that no-load funds were the only future led to a huge mistake. I didn’t understand then, as I do now, that investors who have help with their investments from advisors many times have an advantage over someone simply left to their own devices. I was in my mid 30s and believed that it was

obvious

that all investors would go the no-load route and

oblivious

to the fact that at that time, most investors preferred to work with advisors (And still do.)  What could have been a huge jumpstart in the mutual fund business was lost, and even though our no-loads did okay in attracting investors, I missed several obvious opportunities for my firm. Indeed, at the time, we called our funds “Strategy Indexes”

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which would have given us an enormous head start on what have come to be called Fundamental Indexes, so, this error had a compounding effect.  

I think the lesson here is understanding that just because you have a belief or preference, however strongly held, it doesn’t negate those who differ with you. Being a true believer in almost anything does not lead you to make the best choices nor does it allow you to approach things with a more open mind. Had I been less dogmatic, I could have taken advantage of a rare opportunity for my relatively new investment management firm to partner with one of the most powerful brokerage firms on the street and potentially popularized factor-based investing to a wide group of investors much earlier than ended up happening. I think the important lesson here is that there are many legitimate paths to succeeding, and you should avoid dogmatic responses and keep an open mind, as long as the alternatives are legitimate and can help others.

1.     In the first few editions of my book, I proclaimed price-to-sales to be the “King of Value Factors.”

In 1996, when the first edition of my book came out, I was super excited to be offering a compendium of the actual long-term results of all of Wall Street’s favorite measurements for determining if a stock was a good investment or not. At the time, I only looked at individual factors and price-to-sales proved itself to be head-and-shoulders above all the others. Other than a great book by Ken Fisher called Super Stocks, which focused on how great the price-to-sales ratio was, at the time, it was a very obscure factor that wasn’t popular like PE or Price-to-book. That made me even more excited to proclaim it the “King of Value Factors.”

With hindsight (another nasty behavioral bias), this was a rookie mistake. Had I given it any thought, I would have remembered that you can make anything look good if you varied the amount of time in your analysis. But I thought, gosh, this is decades of data, surely things won’t change that much going forward. But, of course, they do. Instead of focusing on how value factors in general did in identifying attractive stocks, I rushed to proclaim price-to-sales the winner. That was, until it wasn’t. I guess there’s a reason for the proclamation “The king is dead, long live the king” when a monarchy changes hands. As we continued to update the book, price-to-sales was no longer the “best” single value factor, replaced by others, depending upon the time frames examined. I had also become a lot more sophisticated in my analysis—thanks to criticism of my earlier work—and realized that everything, including factors, moves in and out of favor, depending upon the market environment. I also realized that you were far better off seeing how a stock scored on a composite of value factors that took more aspects of the balance sheet into account.

The lesson? No single factor or fundamental piece of data is ever the answer or solution to the complicated question of how to pick stocks that outperform. For example, I have long been a fan of shareholder yield (Dividends+Net buy backs) but even though it performs well on its own, it performs much better when selected from a group of stocks that are very cheap; have good earnings quality and have a high conviction in their buybacks, as evidenced by percentage of outstanding shares they are buying. As Einstein is reputed to have said, “make everything as simple as possible, but not simpler.”

2.     In the late 1990s, I was approached by the American Stock Exchange to do a series of ETFs based upon What Works on Wall Street. I declined.

This one makes me feel like Forrest Gump, only in reverse. I’ve recently read an interesting article on how our memories play tricks on us and fill in details that never actually happened, probably so that we can keep a consistent view of ourselves and decisions that we make. Luckily, I have been an inveterate journal keeper, so I am able to go back and see what I was thinking without the benefit of hindsight or new magical details inserted by my comforting brain. ETFs were pretty much brand new at the time, and I thought they were a great idea, but having just launched a mutual fund family, I was worried about channel conflict. I was also worried about endorsing a new, and as of that time, untested investment vehicle. (As you will see later in this post, I quickly overcame my objections to that at precisely the wrong time.) On top of these concerns, the fees would be tiny by the standards of the late 1990s. So, I passed.

I think the main lesson here is that sometimes you just need to jump in with both feet if you think something is a great innovation and worry about the other concerns later. I knew that ETFs offered several very attractive improvements over mutual funds, and I had the opportunity to have a large partner launch tie-in strategy with What Works on Wall Street. What’s more, we got on the investment world map by offering something that was new at the time—factor-based portfolios. I should have thought more deeply about how well two innovations tied together could have worked. But, I didn’t. I let the circumstances of the moment—new way of investing; new mutual fund family, relatively new company—blind me to the strategic opportunity at hand. I let tactics trump strategy, and I’ve come to believe that tactics should always be the servant to strategy.

1.     I started a company called Netfolio in 1999. It was one of the first robo- advisors and I got a U.S. Patent for a “System and method for selecting and purchasing stocks via a global computer network.” In early 2000, I got a massive financial offer to buy a portion of the company from one of the largest Investment Banks on Wall Street. I turned them down.

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What is it with me and large banks? Obviously, I was as wrapped up in the zeitgeist of the times, which thought that only “pure” online companies would go on to receive multi-billion-dollar valuations. At the time, venture capitalists and professional investors thought it beyond idiotic to have any association with “bricks and mortar” companies. They were so 20th Century. The rules were quite simple (and in retrospect, insane) that only pure-play Internet companies could get the backing to move to IPO, and so, I went against every instinct I had, and said no.

To really show you how easily people, and I mean ALL people, can get caught up in a mania, I made the decision to decline the investment even though I had written a scathing piece in April 1999 called The Internet Contrarian, in which I confidently wrote: “Because the numbers ultimately have to make sense, the majority of all currently public Internet companies are predestined to the ash heap of history. And even if we could see the future and identify the ultimate winner in e-commerce, at today’s valuations it is probably already over-priced.”

So, incredibly bearish on the Internet and the overpriced names, I nevertheless seemed to believe (hope?) that my Internet company was the exception to the rule. After all, there were a number of other VCs who were confidently saying they could offer even better terms without me having to link the company to the offending “bricks-and-mortar” legacy firm, which was, you know, a hugely successful actual business with actual revenues and earnings! Shudder. But such was the mania of the moment that it had all of us—even those of us who in our saner moments had looked at the actual numbers—and determined that the entire thing was unsustainable.  

And then, the walls came tumbling down. In March, 2000, an enterprising, smart reporter I know at Barron’s named Jack Willoughby wrote a story called Burning Up in which he pointed out the simple math of the situation: “Internet companies are running out of cash—fast.”

Boom.

It seemed like that one story snapped everyone out of the delusional fantasy that the rules of economics had been repealed and that unicorns and rainbows could be monetized. The other VCs and their better terms? Vanished. Everyone saying legacy companies were destined for the dustbin of history? Silent. Lessons (re)learned?

Many.

I’m lucky that I keep journals in real time, in that it helps me avoid something we all face—hindsight bias. Our brains are very complicated, and they manage to fill in our memories with thoughts we didn’t think at the time; with things we didn’t know at the time. It’s almost impossible for us to accurately recall what we were thinking and the version our brain serves up to us is, to be charitable, very kind to us but also incredibly wrong. Here are some things I wrote down at the time:

1.     Be humble—arrogance killed some of the best potential deals in history.

2.     Take the money—when someone else wants to give you a lot of money for something you have, let them. Work out the details afterward.

3.     Don’t overanalyze—everything will eventually break down and from some angle will not make sense.

4.     Understand people’s motives—they are not always what they seem.

5.     Understand how fragile the average person is—it will always come out at the worst possible time.

6.     Murphy was an optimist—expect six-sigma events as normal, not extraordinary.

In another journal, I wrote that hubris—excessive pride or self-confidence—was an expert assassin of even well-founded hopes and dreams. Whom the gods would destroy, they first make great, especially in their own minds.

What’s the Point?

The point is simple—mistakes provide a lesson-rich environment. But you’ve got to own your mistakes. You’d be compounding them if you tried to point your finger at anything or anyone other than yourself. The most successful people I’ve met have usually also been the ones who not only made the most mistakes but also always owned them. If you have the ability to say “I was wrong” and truly believe and learn from it, you’re close to gaining a new superpower in life.

So many people refuse to own their own mistakes, blaming others, bad luck, bad timing, you name it. If life give you a choice to compete against any type of person, always pick the ones that think most outcomes are due to luck. Does luck play a part? Almost always, but I rarely think—outside of lottery tickets—it’s ever the overriding reason for an outcome. Having the ability to learn all the lessons you can from mistakes you’ve made makes you better prepared for the next time. For as Isaac Asimov said, “in life, unlike chess, the game continues after checkmate.”