Greatest Investment Mistakes: Living in the Bubble

Group Think Today's topic is the fourth and final installment of Greatest Investment Mistakes. The first three were: not knowing when to seek professional help, leaving the stock market without returning, and listening to a single source. This column extends that third subject to being surrounded by those who think similarly.

Writes Bob, "In the late 1990s, I was a sales engineer for a broadband access startup in Northern California. We engineers were given a generous number of stock options--15,000 or even 25,000 with a strike price of $1.15. Our company had an IPO. When the six-month blackout period ended the stock traded at $200. Teams of financial advisors were brought in telling us to not exercise the options, not sell the stock. Sure we were rich, but we should aspire to incredible wealth."

"I was not financially naïve. I had read several of the investment classics. I was a Morningstar subscriber. Still, I drank the Kool-Aid like everyone else."

Shortly thereafter, that stock was delisted. The options that would have been worth $199 per share at the stock's peak price expired, worthless. Concludes Bob: "Maybe human nature never changes. Mine sure didn't."

Mum Was the Word Human nature can change, but it generally requires a prod. Was anyone prodding Bob? Not his giddy coworkers. Not his company's managers, who were equally entranced--tech company executives are no better at avoiding euphoria than are their employees. And not--shamefully--those teams of financial advisors. It appears they abandoned their professional duties, perhaps also caught up in the moment, or perhaps because that company signed their checks. Either way, those advisors should have punctured the bubble--but they did not.

(As regular readers may recall, 48% of my portfolio consists of stock in Morningstar MORN. So, who am I to be talking? Well, there are several differences in our situations. One, Morningstar is a far more-stable business than a New Era tech company. Second, between purchasing the remaining 52% and paying taxes, I have sold most of my Morningstar stake. Third, people do tell me that I am wrong!)

Without encountering outsiders, Bob was unlikely to escape the pack. His was a typical experience. Back in the day, one of my friends had the good sense to marry a freshly minted Stanford MBA, who rejected the established Silicon Valley firms for a startup. Good decision; it thrived and went public. Better decision; he exercised his stock options near the market peak, in 1999, using the proceeds to purchase a house, mostly in cash. Commented his wife, "We figured that if we were going to own something overpriced, better that it be something tangible."

That stock soon returned from whence it came. Some other employees exercised small portions of their options on the way up, but my friend's spouse was the only one to enjoy a substantial profit. All the others were talking to themselves.

Party Affairs Now let's consider politically motivated bubbles. Mr. C. relates his father's investment blunder:

"My father is a staunch conservative. Rewind to early 2009, Obama has just been elected as president. And the talking heads are fuming. According to them, our economy was doomed, we were going to be taxed into oblivion, Obama wasn't even born here. My dad was distraught, heartbroken even. As the markets plummeted, the talking heads screamed louder about how Obama had ruined the economy and the markets crashing was his fault."

"My dad took this as gospel, and in perhaps the worst timing scheme possible moved everything to cash with what I estimate was a 40% loss. In his mind, he outsmarted the market. Then, convinced Obama was rigging the stock market with quantitative easing, he did not reinvest until eight years later--about four months ago. With Trump as president, he feels confident that it will be smooth sailing."

Eight years out of stocks, from 2009 through 2017, was indeed an error. Fortunately, the same political certitude that cost Mr. C's father dearly during the long equity runup has profited him in recent months. Those who advised him to exit stocks because of one president suggested that re-enter because of another. As his belief in their wisdom remained unchanged, he did so--thereby accomplishing the difficult feat of escaping the bear trap. Their counsel might not have soundly derived, but it pushed our subject in the right direction.

That lesson applies in reverse. Left-wing pundits who concluded in 2009 that voters should favor the financial markets because a Democrat occupied the White House, then turned bearish after Trump surprised on election day, were no less wrong. (However, there were fewer of them, as the left doesn't often attach stock-market forecasts to its political commentary.) Presidents don't much affect stock prices--and to the extent that they do, their actions are difficult to predict.

Dissenters Wanted Surrounded by those who work at the same firm, own the same stock options, and have the same corporate outlook, or listening to those who have the same political views, arrive at the same diagnosis and expect the same outcome. Whether it occurs through work or through politics, living in a bubble has the same effect. It leads to investing by conviction, with beliefs that are not properly tested or challenged.

The cure for that is obvious: Court opposing views. Consider the views of those who disagree. Consulting a financial advisor is one logical approach. Bob didn't have much luck with that, but I think he would have had happier results had he talked with someone who was completely independent of his company. One reader writes to me that he does his own investing, but every five years he pays an advisor for a checkup. If the reader has an investment blind spot, he may miss that when conducting a self-analysis. An experienced outsider probably will not.

Next up: Greatest investment triumphs. If you are proud of a decision that you made because it was well-considered at the time, please let me know at john.rekenthaler@morningstar.com We can learn from our successes as well as our failures.

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.