Seven Tips from Seven Years, Tip #1: Avoid Running with the Lemmings

Wisdom is the principal thing; therefore get wisdom: and with all thy getting get understanding.

Proverbs 4:7


On November 25, 2002 I took a leap of faith. At the time I had recently left the practice of law but was not certain what my next career step should be. For the previous 3-4 years I had been investing, initially in my 401(k) account, and then supplementing that with a brokerage account. Since I had saved a little over a year's salary that I could use as seed capital, I concluded that trying my hand at investing full-time was the option for which I had the greatest amount of enthusiasm.

Seven years and 6800+% later, I am still plugging along. The journey has not been easy, nor has it been particularly smooth. Being an investor is the ultimate eat-what-you-kill way of making a living. Volatility can wreck havoc on one's nerves and net worth. But on this anniversary of stepping out into the great unknown with no safety net by way of an alternate source of income, I have reflected upon the many lessons I have learned as an investor. Over the next week or so I will expound upon the seven insights that have proven to be most valuable to me.

Avoid Running with the Lemmings. The biggest mistake most investors make is reversing the most basic maxim of investing: Buy low, sell high. When I first started investing in the late 90's, Asia had just gone through a massive asset bust. Foreign investment was being yanked out at record levels. Accordingly, many Asian stocks were trading for pennies on the dollar. It was a wonderful time to run against the crowd and buy, buy, buy. But most retail investors saw the huge negative returns around 1998 and sold whatever stocks/emerging market mutual funds they had at what ended up being multi-decade lows.

Conversely, much of the foreign investment money that was being pulled out of Asia in the late 90's went flooding into the NASDAQ. Annual returns of 40, 70, 100% and more became de rigeur for investors. Making money had never been this easy, or fun. It was as simple as finding a publicly traded company that utilized or serviced the internet somehow, and then using the internet while "at work" to follow the hour-by-hour upward movement of your stock!! The old fuddy-duddies (such as yours truly) who were wringing their hands about outrageous valuation multiples, lack of earnings and unsustainable growth rates, were written off as morons who lacked the vision to appreciate the transformative nature of the New Economy. Like any mania/bubble, enough people got super-rich that it sucked in the lumpen-investors. Even those who were otherwise financially sober, cautious investors could only stand watching their neighbors and colleagues make huge sums of money for so long before jumping into the easy money fray.

But just as it appeared the stampede of lemmings (driven to frothing madness by the Wall Street shills constantly paraded out on CNBC) would trample every skeptic in their inexorable path to further financial riches, the cliff appeared. At first it was somewhat akin to Wily Coyote's ill-fated pursuits of Roadrunner. The NASDAQ dipped hard. But while no longer running on solid ground, and instead careening into thin air, the lemmings kept pumping their legs; this was not a crash, but rather a dip which provided a buying opportunity. The masses were convinced, as had been dutifully drilled into their heads by the unholy alliance of Wall Street and the financial media, that a prolonged downturn in the stock market was unthinkable. By the time most people realized they had been sold a bill of goods, 401(k) and brokerage accounts across the country had been brutalized; years of savings evaporated.

But I have to admit, the REALLY instructive thing about investing is what would occur in the following 5-7 years. I mean prior the 2000, the most recent market crash had occurred when the most sophisticated piece of technology in existence was a vacuum tube. Few investors had been alive during the stock collapse of 1929, so it was easier to cut them some slack for not foreseeing the imminent market downturn in the Spring of 2000.

But by 2002 investors had seen first hand a full-blown investing mania and the financial destruction it had wrought. These should have been grizzled, shrewd and deeply cautious individuals who would be well nigh impossible to hoodwink again, right? Oy Vey.

First came the housing bubble. This was actually precipitated by Greenspan's stupid and misguided efforts to avoid a recession brought about by the aforementioned stock market crash. People became even more zealous in their faith that the housing market was their financial savior. Construction of residential homes grew at a pace that was more than 6.5 times the rate of population growth. But with more than 1/3rd of home buyers purchasing as second homes or for investment purposes, there was an illusion of never-ending demand and ever-escalating prices. Lemmings everywhere got their legs pumping again. Home and condo flipping became the new day-trading (with similar prospects for long-term success). And once again, the financial services industry stood at the ready to give investors plenty of rope with which to hang themselves (as well as the institutions loaning the money, but that is another story): zero-down, negative amortization loans, zero percent interest teaser rates, and no documentation mortgages. It was all good. Collectively people believed that we could somehow all get rich by selling our houses to one another ad infinitum. But it was just a game of musical chairs with too many participants.

By 2007 other asset markets began to join the easy-money party. Stocks were particularly frisky. While the NASDAQ never ascended to its 2000 high, all the broader indexes had significantly exceeded their fin de siecle pinnacles. By the end of the year, for the only time in my (albeit brief) investing career, financial commentators were bullish on every financial asset; whether it was American stocks, foreign equities, gold, bonds, real estate, commodities, art or fine wine, "experts" projected ongoing price increases. This was as close to a bell ringing for the top of a market I have ever seen. 2008 obviously came as an unpleasant surprise for most everyone in the investment world.

So, other than being a very self-indulgent, long-winded and irreverent review of recent American financial history, what is the take-away? Well, all of the above events demonstrate that the quickest way to lose large sums of money is to follow the crowds when investment manias/bubbles arise. Similarly, when the masses eschew and revile a particular asset, that usually represents a very attractive entry point. Essentially investors operate within a continuum of greed (which in its most extreme form manifests in high levels of complacency) and fear (the hallmark of which is often panic-selling). As a deep contrarian, I firmly believe the only way to achieve substantially above-market returns is to bet against the crowd when extreme sentiment manifests itself in the markets. At one point my investment strategy was almost as simple as finding out what friends, colleagues and acquaintances were doing with their money, and taking the opposite side of the bet. It has served me quite well over the years.

Well, thanks to the wonders of modern technology, I am posting this as I descend into JFK for a visit with my in-laws. The next installment will be how to avoid getting consumed by the parasites. I hope one and all (and by that I mean the two people who are reading this) have a wonderful Thanksgiving!!