Chapters:
00:00 Mistake 1: Not investing
03:50 Mistake 2: Short-term trend over-extrapolation
08:15 Mistake 3: The narrative fallacy
11:20 Mistake 4: Making your investment decisions based on emotions
13:08 Conclusion
Transcript:
The biggest investment mistake by far is not investing. Except, of course, that one time when you invested your life savings into crypto and you lost everything the next day. But seriously, investing may seem risky, but the only surefire way to lose purchasing power is to hold cash.
Cash is the worst asset you can hold, from an investment perspective because it doesn’t generate any additional money and it loses value over time due to inflation. Inflation means that the cost of goods and services in an economy increases due to the government printing money and everything becoming more expensive. In reality, it’s a little bit more complex than that and the government doesn’t usually print money, but it’s a very apt metaphor. Cash becomes less valuable over time, making you lose purchasing power. The things you can buy with $100 now versus $100 in the 1950s are radically different. Just ask your parents how much their house cost and try to find a similar house now for that amount of money. Good luck! Money is just a piece of paper or even a number on a screen these days. It only has value to the extent that other people agree that it has value and we can use it as a means of exchange. What you want from an investment is an asset that actually produces money and can grow over time. In this sense, there is nothing like investing in stocks.
Jeremy Siegel has done a great job in his book “Stocks for the Long Run” showcasing that the best asset class to invest in over the long run is stocks. Nothing beats stocks for relatively reliable investment returns over time. On average, over the long periods of time you can expect about a 10% annual return on investment from stocks, which is higher than any other asset class. Now, if your last purchase on Amazon was the book “Get Rich Quick with Dropshipping” you might scoff at a 10% return on investment. “It is going to take ages to get wealthy that way!” And it will. You have to invest in stocks for the long run. But a return like that snowballs into very large amounts very quickly. This is called compounding in economical terms. We can calculate exactly how much money we’ll have if we put a certain amount of money in any asset class with a certain return on investment, in this case stocks with a let’s say a 10% return on investment. The amounts get pretty wild, even with small investments. For example, if you set aside a 100 a month and put $1,200 every year into an investment that generates a 10% return on the investment over the course of 40 years, that turns into $584,000, over half a million. Not bad for setting aside 100 a month. If you can set aside 200 a month, the expected value 40 years later is over $1 million. So it’s not an exaggeration to say that most people can become millionaires in their lives if they are financially prudent and smart with their investments, even if they can only set aside small sums of money every month.
Now, of course, some people might not be able to set aside 200 a month, but most people, in my experience, can. You should really look at cost saving. For example, one of my friends that I recently talked to about this said he could not possibly set aside 200 a month, and he was drinking four Red Bulls a day and paying 1.50 per can for that. So he was literally paying $180 a month on Red Bull. If he just switched Red Bull to coffee or some cheap energy drink, that would alone much be enough become a millionaire over the course of his life. The compounding rate also has absolutely wild effects on how much money you’ll have by the time you retire. If we change that return on investment from 10% to 5%, which you might get with more prudent investment or worse investment, you will have 152,000 after 40 years. That’s still nothing to scoff at, but it is a far cry from a million. If you can do better than the stock market on average, and you can beat the S&P 500, let’s say you get a 12% return on investment, than even with only a 100 set aside per month, that will in 40 years time be over a $1 million as well. So even 1 or 2% differences in your annual return on investment rate will have massive effects on how much money you’ll have by the end of your life. This is why it’s so important to avoid the following investment mistakes.
The second major investment mistake that almost every investor falls prone to when they start investing is short term trend over-extrapolation. We see a graph, it’s going up and we think: “Oh, I see the pattern! It keeps going up!” So we invest, and it turns out it starts going down. For example, look at the Nasdaq composite up to early 2000. You would think: “Oh, that’s a nice graph!” And you get FOMO, fear of missing out. You don’t want to lose out on these massive gains because the stock market is rising and rising, and there seems to be no stopping it. Here’s the same graph up to 2003. In the crash after the great “Dot-com” bubble the market fell back to levels below 1997. And if you invested at the very peak of the bubble and you sold it at the low you would have lost 75% of all your investments. Trying to predict stock market returns from price data is called technical analysis. And the short version is that it doesn’t work. There is such a thing as momentum trading. Momentum is a factor that has validated alpha in the markets, but it’s very difficult to trade on it. And if you don’t know exactly what you’re doing, it involves very high effort, very high trading costs and a lot of expertise to successfully take advantage of momentum in the stock markets. So if you’re not an advanced investor that knows exactly what they’re doing, I do not recommend momentum trading, and technical analysis as a whole is best left untouched. Don’t try to predict stock market returns based on the shape of the graph.
To illustrate this, when I was taught statistics at UCU, every year the teachers would give the class the exercise of trying to predict stock market returns. Now, for those that don’t know, UCU is in the Netherlands the Honors College of Utrecht University. Utrecht University by many rankings is the best University of the Netherlands. So you are taking the people that go to the best university in the Netherlands and you’re getting the Honors College. So at UCU you don’t just have the people that go to the best university in the country, you have the people that were selected to go to the Honors College from the people that were already going to the best university in the country. And then you take the people that are interested in statistics from that sample, and you have all of those people as a group every single year try to predict stock market returns from price data. The result: nobody has managed to predict stock market returns with any degree of accuracy that would result in actually generating positive alpha, which is the economical term for generating superior investment returns.
Some of you might mention Jim Simons of Renaissance Technologies, but the number of people involved in that project, the investments in it, the trading algorithms, the technology that’s required to do those things, it is far, far beyond the scope of any individual investor. So take home message for the average investor. Don’t bother with technical analysis, ignore the shape of the stock market graph completely. You do not base your investment decisions based on the shape of the stock market returns graph. The same mistake also applies to choosing a fund manager. Most fund managers, in research, have been shown time and time again not to outperform the market, and the ones that do typically don’t outperform the market any more over the next period. So it’s mostly luck. Many investors not aware of these data still look at investors with the best returns and try to select the one that has outperformed the market over the last couple of years, or even ten years, and it is simply not a guarantee that they will be able to do so again. Most investors that outperform the markets just got lucky. If you want someone else to manage your funds you should not just look at their past returns. You should look at their investment strategy. Their investments strategy is a far better predictor of their ability to generate returns on investment than their past performance, especially when you’re measuring it over a few years.
If you’re looking at someone like Warren Buffett and you can go back many decades in time then it is a decent clue, but especially over short time horizons it really doesn’t mean anything. And it also applies to countries. Many investors these days are all in on the United States of America. Now, I love the United States of America, it’s a great market, it’s a free country, it’s a capitalist market, they have some of the best companies in the world, it’s a very competitive market. There’s a lot to be said to invest in the United States and pretty much anyone should probably be investing in the US to at least some extent. However, because a country has had a good run for the last, say, ten years does not mean it will perform well over the next ten years. In fact, historically, as you can see in this graph, usually when a country outperforms for a certain period of time it will underperform in a period thereafter. There has to be some global balance because the economies of countries just like those of stocks, the steel industry or the credit cycle are cyclical. So outperformance over a certain period of time is actually an indicator that there will be underperformance in the time thereafter.
The third investment mistake that we are so prone to fall prey to is the narrative fallacy. Humans love stories. Our brain is wired to construct stories. There’s a lot of psychological research showing that how our brains primarily operate is to take all the information that is available to us, turn it into one story that’s relatively coherent, or at least as coherent as possible with the facts that we have, and then that story is what we think. We as humans are very bad at doing scenario analysis and looking at facts objectively. We are very prone to overvalue the worth of a narrative or a story. You see this, for example, in books that sell well. Most books, they don’t just give you the facts, they tell you a story so that you will remember facts and that will really hit home. It does a lot better than just presenting people with facts. Similarly, we see narratives in the media all the time. And what’s of very popular, a certain narrative, a certain story, during a certain time periods can vary dramatically from one period to the next. Turns out that narrative had no merit whatsoever, but still it went absolutely viral and it was very catchy. And this makes us very prone to make investment decisions based on the narrative like that, especially when it is combined with a short term trend. So if we combine the previous mistake of over-extrapolating current trends, combined with a plausible narrative that suits that trend, then many investors think: “Oh, this is it! There’s no doubt in my mind. It seems so clear. Everything fits.” And that is exactly what you should be very skeptical. Because investing is messy, it is exceedingly difficult to predict the future or stock market returns or even earnings of any company, not to mention the geopolitical situation, macroeconomic indicators… There are so many factors at play that investing becomes an incredibly messy game that is much more like bridge or poker than chess or mathematics. For example, we currently have the narrative of AI. AI is supposed to turn the economy into hyperdrive and “The Magnificent 7” stocks are supposedly the ones that will benefit the most. However, if you really start looking at data of AI and ask critical questions it becomes clear very quickly that the current AI narrative is a lot like the aforementioned “Dot-com” bubble when the internet became a thing and people thought: “Oh, this is going to revolutionize the economy, all the companies that are involved with the internet are going to make absolutely boatloads of money.”
Now that similar line of reasoning is applied to AI. However, AI is extremely expensive and historically what we see from technology innovations is that people overestimate the impact after a breakthrough. Usually, breakthroughs happen cyclically. There’s one breakthrough like ChatGPT and then it takes a long time before there is another breakthrough. Moreover, it is very difficult to predict who’s going to benefit exactly from those breakthroughs. With the internet, with AI, is it going to be Google? Is it going to be Microsoft? Well, nobody predicted it would be Open AI. So who exactly is going to benefit? What exactly are the costs and benefits of the technology? Is it really profitable to begin with? Currently, AI is not actually profitable for many companies. Many companies are investing enormous amounts of money in it, but it’s not actually generating major free cash flows. So I would be very skeptical of any narrative like AI or anything else and rather you should base your investment decisions based on time tested economical theory and hard data. Speaking of making investment decisions based on emotions rather than hard data…
Investment blunder number four making your investment decisions based on fear and greed, or emotion in general, as opposed to hard data. Again, we see this trend that hard, objective data are the best decision making criteria for investments. Warren Buffett, arguably the greatest investor of all time, has famously said that: “You should be fearful when others are greedy, and you should be greedy when others are fearful.” However, what most people end up doing is exactly the opposite, and it seems so easy, rationally speaking, to think of these things: “Oh yeah! Oh, of course. Duh!” But when it really comes down to it and there is a stock market crash and all the headlines are saying: “The economy is going to crap”, “There’s going to be a collapse of the financial system”, “You have to get your money out of the bank”, “Banks are going bankrupt” When you see all of those things, you see the headlines, other people are pulling their money out, it is very easy to become scared and pull your money out and that is the worst thing you could possibly do. If you take your money out during a crash then you are selling low.
What you want to do is exactly opposite. You want to be counter-cyclical, you want to sell high. So now in that sense might actually be a pretty good time to sell for US stocks because valuations are at historically very high levels, and you want to sell high and buy low. Investing by nature is a very contrarian activity. You want to be counter-cyclical, contrarian, you want to not do what other people are doing. You cannot expect to outperform the market and earn more money than other people when you do the exact same things other people are doing. You have to do something different than other people are doing. In fact, investing is largely a zero sum game because you are operating on a market. When you are selling, someone else has to be buying. So your loss is their gain and vice versa. Therefore, logically, the only way you can make money off the investment markets is by doing things different than the norm. You have to make money off the mistakes of others. And I would note this also goes for life in general. You cannot excel in life by doing exactly what everyone else is doing. Conformity is the surest path to mediocrity.
If you’ve made these investment mistakes, don’t feel bad. I’ve made all of these mistakes myself with my own investments. But that is how we learn and get better. So I really hope this video will help you avoid these mistakes with your investments and help you make a lot more money. And if you are a serious lifter that’s interested not just in optimizing their physique, but also their finances and their lifestyle in general, check out my upcoming personal development course. It is loaded with evidence based content to get the most out of your life. I hope you’ll enjoy it.