You expect financial pundits to speak with authority. “The market will do this.” “The economy will do that.” And of course they should be right, because who’s going to listen to a money expert who makes mistakes?
But I’m no financial pundit. I’m just an early-retired engineer, reporting on my real-life experiences in saving, investing, and retiring early. And, yes, I have made some mistakes.
On average, I’ve managed my money well and enjoyed good fortune in life. So, much of this blog is based on talking about my successes — financial independence, early retirement, personal freedom, adventure travel.
Unfortunately that story can sound arrogant at times, even when it’s not intended. So, as an exercise in reality and humility, I’m going to explore some of my notable investment failures, and lessons learned. As you will see, there have been plenty of them over the years….
Betting on a Dot-Com
It was August of 1999. I was 39 years old, living through what would later be called the “dot-com bubble.” Only it didn’t seem like a bubble back then. I was a software engineer and had been riding the personal computer wave as an employee or entrepreneur for my entire career. I knew small computers. I knew the technology was revolutionizing the world, and I knew how people were making money at it. Those exponential valuations on dot-com stocks made sense to me, for a while. Now, after years of frugal living and careful saving, I was beginning to accumulate my own assets. Financial independence had appeared on my radar. Maybe, with some savvy bets on Internet stocks, I could grow my assets even faster. Maybe I could even retire early?
The latest hot technology in the stew of new hardware and software was Linux. This was an open source operating system that had huge mind-share among the geek set, promising to compete with Microsoft and Apple, especially on the web and embedded in devices. Even though the software itself was free, for-profit companies were springing up around it. To be honest, their growth path never made perfect sense to me. But I knew Linux was hot, and I fancied that I had some “special” insider knowledge that gave me an investing edge. My family and friends in other professions had never even heard of Linux, but I was in the know….
I’d been watching the IPOs of various Linux-related companies. As each started trading and shot off into the stratosphere, I kicked myself for not getting on board. Finally, that August, I got wind of a pure Linux company in time to buy the IPO. It was Red Hat. The stock was offered on August 11, 1999 at $14/share. But, of course, only the insiders get the initial offering price. As is usually the case, the stock began trading to the public at several times that number.
I held my breath and bought 20 shares at $41.94. The stock continued up the next day. I watched as my money almost doubled. Wow, this was going to be easy! I bought another 40 shares at $73.44. Then, finally the price seemed to level off. Four days later I sold 20 shares at $75, netting a profit of almost $700. I patted myself on the back for “locking in a profit.” How could I lose now?
I should have quit while I was ahead. But the stock continued to tantalize. By the end of the year it was trading at over $100/share. Yes, I had almost tripled my early money, in a few months. Had I invested my entire net worth originally, I’d be rich by now! Fortunately I had the good sense not to take that kind of risk. But what should I do next? There was never any question in my mind: Stocks always went up over the long haul, right? I’d just hold on for those long-term riches…
A year passed, during which Red Hat’s price slowly drifted downward. Eventually, I was nursing an unrealized loss. But in August of 2000 I saw a chance for redemption: I bought 120 shares at $22.84. The price seemed like a “steal” since I’d already seen it so much higher. But, for the next few months, I watched my new position, along with all my other shares, crater.
It always felt to me like the stock was wavering, but would recover. The experience was a reminder that, on a daily basis, you cannot tell a stock’s direction. That’s because it’s impossible to see or predict trends when you are in the middle of them. Finally I lost heart. On November 22, 2000 I sold my entire Red Hat holding of 200 shares for just $7/share — half of the IPO price, a fraction of what I had personally paid for my shares over the past year. The loss obliterated my earlier small gain.
Altogether I put about $6,600 into Red Hat — a significant sum for me at the time, though not enough to either threaten my financial security if it did poorly, or bankroll an early retirement if it did well. And how much did I get back out? My total proceeds from sales was about $2,800. I had spent more than a year of my time and energy babysitting a volatile tech stock, taken on substantial risk, and lost nearly $4,000 of my capital in the process!
This story is even more embarrassing looking at the numbers now in retrospect. Like most investors, at the time I wasn’t watching my overall returns. I simply rationalized my results based on gut feelings about daily price moves. But gut feelings about data can easily be wrong.
What a blunder that was for me. The only positive spin I can put on the Red Hat episode is that it was money I could afford to lose. And it bought me some priceless wisdom. Had I made such a mistake with my life savings, I’d still be working now….
Buying a Hot Pick
I learned my lesson with Red Hat and never again tried to pick a hot stock. But I did make a similar mistake a few years later with a mutual fund.
I’ve always been interested in owning real estate as a diversifier. But I’ve never wanted to manage properties myself. I’ve also long believed in diversifying internationally. So, what could be better than an international real estate fund, and a hot one at that?
When one of my investing mentors recommended the Fidelity International Real Estate fund in mid-2007, it had already enjoyed several years of strong performance. “Great,” I thought, “a proven performer.” Unfortunately I didn’t notice the management and portfolio turnover. Nor did I think very hard about buying based on past performance. I now know that recent outperformance is often a negative indicator for future returns.
It turned out I was buying Fidelity’s fund at a peak.
I put $40K into the fund in May of 2007. A year and a half later, in November of 2008, consolidating some of my smaller holdings during the Great Recession, I sold those same shares for about $13.5K. It was a punishing loss. But it was a relatively small proportion of our assets, since we were approaching financial independence by then. More importantly, my sale didn’t change our asset allocation, because I moved the proceeds into other stock funds. Still, it was a stern reminder of the perils in buying a “hot” investment.
Rebalancing Too Late
Though I never made other blunders as bad as Red Hat or Fidelity International Real Estate, I repeated the mistake of watching a niche holding rise sharply in value for a short time, then fall, seemingly forever. My nemesis was natural resources. These are cyclical assets. They are volatile by nature. And that volatility is not “balanced”: Things can go down for much longer than they go up. In my experience, it’s all too easy to lose your money with volatile assets, even if you fancy yourself a serious, long-term investor. Buyer beware!
For years I was enamored of the Vanguard Precious Metals and Mining Fund. Over the course of 2005 and early 2006, I put more than $45K into it. And it did very well, at first. But ultimately I wound up selling that holding, which I had seen nearly double, for about half price: $25K in late 2008. To be fair, the money was reinvested in equities, after harvesting a sizable tax loss. So, again, I hadn’t changed my asset allocation.
I repeated the mistake, to a lesser degree, with T. Rowe Price New Era, a natural resources fund that I owned from 2003 to 2014. To my credit, I trimmed back this outsize energy holding by selling about one-third of it in mid-2008 at a nice profit. But, overall, I waited too long. I should have trimmed back more and sooner. I thought energy stocks would go up forever (we were supposed to be running out of oil, after all), shielding me from other market volatility. When I finally sold out in 2014, the long-term rate of return was mediocre, roughly matching my much larger balanced portfolio of index stock and bond funds. I certainly wasn’t compensated for all the volatility I had experienced in natural resources over the years.
In both cases, I had been outperforming the market handily, and lost it all, because I was too proud or timid to sell. I saw myself as a “buy and hold” investor, and didn’t want to subject my gains to taxes. But that conservative style may not mix well with volatile, niche investments. “Buy and hold” is typically about matching the market return. If you’re trying to outperform the market with a niche investment, the only way you can do that is to buy low and sell high. Some element of luck or timing is required. And many seasoned investors have learned that’s a low-percentage game. If you’re going to “buy and hold,” do it with broad market indexes, or possibly conservative dividend stocks.
Value Tilting for the Short Term
I’ve long believed in owning value stocks. Extensive research shows that they can outperform over long time frames. It just makes sense: If you buy something cheap, odds are better for selling it at a profit down the road. And I always liked that value stocks typically pay higher dividends, so you get some regular cash flow in the present as compensation for any risk you’re taking on.
Not wanting to invest the time or take the risk to pick individual stocks, I’ve owned a variety of value funds over the years:
Around the time I was getting seriously interested in investing and early retirement, I came across a review of the “best investment newsletters.” The top performing newsletter was from a value-oriented stock picker that offered an associated mutual fund. What could be a better bet? I put some money into the Al Frank Fund and held it from 2005 to 2009. Its performance during those years was mediocre at best. In theory, it should outperform over the very long haul. But the high expense ratio (well over 1%) posed a drag on returns, and this was a period when value stocks were out of favor. I doubted I would be able to hang in there for the profits, if they ever materialized. So I sold early and rolled the proceeds into my Vanguard index funds, voting for predictable returns and low expenses.
I owned Vanguard’s Value Index in some form for much of the 2000’s. For a while, I thought it gave me small cap diversification — but I hadn’t read the fine print. It tracks primarily LARGE value stocks. The performance was mediocre. Nowadays I own Vanguard Wellesley Income, a balanced value-oriented fund. Among other virtues, it compensates me with bond income when value stocks are out of favor.
As I learned before, if you buy a specialized niche investment, better be prepared to wait out its inevitable cycles. Despite the theoretical advantage, it’s been a bad decade for value stocks. Over the last 10 years, Vanguard’s Growth Index Fund returned 8.8% while its Value Index returned 6.4%. I would have done better owning a total market index, than trying to pick the style in favor.
It doesn’t take brilliant investing to retire early as I did. Predicting the future and picking stocks that outperform the market averages played no role in my success. In fact, as you’ve just read, my attempts in those directions usually hurt me.
Looking back at my biggest investing mistakes now, years later, it might seem surprising that I was as successful as I was in the long run. But my experience proves that you don’t have to be a perfect investor to succeed in the end.
So, what can we learn in retrospect from my mistakes? What was the pattern, and what did I do right anyway?
My biggest mistakes generally boiled down to becoming undiversified in some way, and not noticing that. “Tilting” your investments away from the broad market into any niche direction is always a gamble. You could underperform or over perform. But the odds are with the former. Because, to over perform, not only do you have to make the right picks, but your timing in and out has to be perfect. Real-world investors will tell you: That is extremely difficult to pull off. Despite my keen interest in investing, too often I was asleep at the wheel and let opportunities to sell at a profit pass me by.
Another theme was impatience. And that’s ironic, because by many standards I’m an extremely patient investor. I wasn’t one to check prices daily or trade weekly. Every “mistake” detailed above extended over more than a year. Most were over several years. Some almost a decade. But it still wasn’t enough. Many investments need decades to come to fruition. Sadly, most people don’t have the patience. And, even those that do may find life and circumstances changing in unexpected ways that force their hand. Moral: Choose an investing style that works over very long time spans, without requiring a lot of highly skilled intervention….
Given the blunders I’ve outlined above, some involving tens of thousands of dollars, you might wonder how I came out on top and retired at 50 anyway. Well, a few key behaviors put the odds in my favor.
In particular, there were two big things I did right:
I failed small. While the sums of money discussed above sound large, sometimes extending to 5 digits, I always played it safe with the 6-digit sums on which I was betting my retirement. And those larger sums were generally parked in low-cost, passive index funds rather than in attempts to pick a few winning stocks or niche asset classes. The odds with the broad market turned out much better.
Secondly, I refused to change my asset allocation or bail out of those large positions. Though I did use the brutal 2008-2009 downturn to sell and consolidate some smaller positions, I wasn’t changing my commitment to stocks. And, over the long haul, that paid off.
Ironically, though I was in the software business during the birth of the Internet, it wasn’t savvy bets on hot Internet stocks that got me to financial independence. Rather, it was the simple habit of investing a large percentage of my salary, keeping expenses low, patiently matching market averages using passive index funds, and avoiding major blunders with large sums, that brought me to early retirement.
* * *