There's No Substitute for Real-World Experience in Investing

I thought I knew everything.

Immediately following graduation and student teaching, I accepted a teaching position at a high-achieving charter school in inner-city D.C. Being hired straight out of college was rare, and I thought that meant my natural skills were blatantly obvious to the principal who hired me. I had crowned myself an all-star before Day One ever arrived.

And then Day One did arrive. I won't go through the gory details, but suffice it to say I had no idea what I was doing.


I'll always remember my overconfidence from the outset. There's a name for that: skill bias. This happens when education and training cause one's confidence to rise faster than their actual, real-world skills do.

Applied to investing
This bias isn't limited to teaching, though. It can be used in just about any situation where a certain level of classroom training causes one to believe that he or she will be automatically successful in the real world.

Studying economics in high school, college, and graduate school is great. But that alone isn't enough to deem someone a successful investor. You have to take your licks along the way. Failure isn't just the best teacher, but for those of us hard-headed enough to think we're endowed with a certain investing acumen, it's the only effective teacher.

An example from the past
One of the biggest mistakes any investor can make is assuming that they are immune to the skill bias. Following my months-long training at The Motley Fool, I thought I knew what it took to spot tomorrow's next monster stock.

Back in July 2011 -- immediately following my training -- I penned an article on six companies I thought could double over the coming months. The article did fantastically well, getting 115 recommendations and over 80,000 hits.

The problem was, my advice was terrible. In hindsight, it's pretty easy to see that I singled out six highly speculative stocks that were heavily shorted, and put faith in the fact that because I deemed them "innovative," they'd prove the shorts wrong.

Take a look at how the six stocks did over the two-month time frame, and how they've done since my article was published.

 Company

2-Month Return

Overall Return

Entropic 

(54.6%)

(41%)

Travelzoo 

(47.4%)

(66.1%)

SodaStream

(48.7%)

(21.9%)

First Solar

(27.1%)

(77.2%)

Coinstar 

(17.3%)

(5.9%)

Ebix 

(13.8%)

(12.2%)

Source: Fool.com.  

Now consider that over those same two time frames, the S&P 500 returned -6.6% and 16%, respectively, and you can see how truly awful my reasoning (and overconfidence) was.

Here's what you can do
First things first. I've developed a mantra I think every investor would be well served to repeat: There's more that I don't know about the market than there are things that I do know. Repeat this to yourself every morning. It's humbling, and it puts you in your place.

Second, do a really thorough job researching your topic, investigating both the pros and cons of investing in particular companies. For instance, when I tabbed First Solar as a possible investment, I didn't give a single reason I thought the company was innovative.

If I had done my research, I would have known how much the company relied on government subsidies,  or that its panels were far less efficient than the competition's.  Since I wrote the article, First Solar's earnings have fallen 42%.  And the future doesn't look too bright, either: Earnings are expected to fall another 20% by 2014.

Finally, realize that some of what you may have been taught in school (or even through a subscription to a premium Foolish service) may not play out in the real world. Things change fast, and there's no way to predict the future with 100% accuracy. After dipping your toes in the investment waters, pick a style that works for you, and periodically revisit your approach for fine-tuning.

One that I still believe in
One company that I think still does have a lot of potential is SodaStream. Where before I saw a gimmicky product, I now know from personal experience how useful the company's carbonators really are.

The company has been able to grow earnings by 42% during the third quarter of 2012, and revenue was up a similar 43%. As SodaStream's carbonators find their way into more and more stores, I could see this trend continuing for a while.

This razor-and-blade company offers an intriguing opportunity for growth that may be harder to duplicate than you might think. Our premium report on SodaStream explains the opportunities as well as the risks in the company. The report comes with a year's worth of updates, so just click here to get started.

The article There's No Substitute for Real-World Experience in Investing originally appeared on Fool.com.

Fool contributor Brian Stoffel has no position in any stocks mentioned. The Motley Fool recommends Ebix and SodaStream. The Motley Fool owns shares of Ebix and SodaStream. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.


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