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The Fatal Flaw in My Investing Approach

Tyler Crowe, The Motley Fool

No matter if you are an investing rookie or a seasoned market veteran, no one is a perfect investor. Even Warren Buffett has admitted to making mistakes along the way. Of course, it's not the end of the world if you have some flaw in your investment approach. What can be problematic is not being able to identify those flaws and letting those same issues continually eat into your potential gains. 

To be the best version of yourself as an investor, it's worth taking the time to look back at your track record and see the common threads of your investing failures. So in the spirit of this kind of investment self-reflection, I thought I would share with you what I think is the biggest issue with my investing approach, why I seem to fall for it so frequently, and how I try (not always successfully) to avoid it. 

Person burying their head in a laptop holding a flag that says help.

Image source: Getty Images.

Creepin'

If you're like me, you have probably looked back at your investment failures on a stock-by-stock basis. One bad investment may have been because I didn't completely understand how a business plans to monetize a great idea. Another may have been a willingness to forgive a somewhat shaky balance sheet because the growth opportunities looked so great. Each bad investment can look like it is a unique mistake, and there is no doubt that each poor investment we make will have unique reasons for not turning out as expected. The more I look back at my investing mistakes, there is one thing that they all seem to have in common: My inability to sell the stock when my investment thesis is no longer valid.

One thing that I drilled into my head early on as an investor is to avoid letting costs eat into my returns: Don't move in and out of stocks all willy-nilly. Long-term capital gains taxes are much more favorable then short-term gains rates. Make your purchases or sales large enough that trading commissions and fees are marginal expenses. 

Unfortunately, my avoidance of trading has gone so far that I habitually become a victim of thesis creep. 

The constant reminder

Perhaps the best way to explain this investing flaw is to go through one of my worst-performing investments: Offshore oil and gas rig company Seadrill (NYSE: SDRL)I bought the stock back in 2014 because the company had the youngest, highest-specification fleet of rigs on the water. Having these desirable assets would attract a premium price for contracts and the company would be able to capture market share from competitors with older fleets. I acknowledged that the company's debt load and future obligations were higher than I would like, but the contracts it had in place plus the ability to win an outsized share of new contract work were enough to cover those obligations. 

That was the case, until it wasn't.

As the price of oil sank, Seadrill's customers significantly reduced their capital spending budgets. Not only was Seadrill not winning any new contracts, but it was receiving early contract termination notices. If I had stuck to my investment thesis, I would have sold right then and there. The thing that was assuaging my concerns about future obligations was no longer in place. Instead, my thesis shifted: The company's cash load and its high rate of insider ownership would ensure that it would be able to work through its debt load issues until the oil market turned for the better.

It didn't happen.

My thesis started to break down. Despite the monumental decline in the company's financials and stock price, I stuck with my position. It has been my worst investment loss and the most glaring example of my investing flaw. I have other stocks in my history that haven't followed the script, but this one is the one I use to remind myself of the perils of thesis creep. I even keep a token share in my portfolio as a constant reminder of what I need to consistently be aware of when evaluating my stocks.

(Yes, I'm completely aware of the irony of keeping a stock around to remind oneself about not hanging onto a stock too long.)

Self-knowledge goes a long way

We all have our flaws as investors, and identifying what they are can be a helpful tool in avoiding future failures. While I haven't been able to shed my habit of thesis creep, there are a couple adjustments I have made to my investing style that mitigate that risk:

  • I stick to simpler investment theses and business models that don't require catalysts or things to fall one way over another. Any "if" in a thesis is a failure point I may not be able to identify quickly enough.
  • I build an easy-to-measure criteria into a thesis (I'm a fan of multiyear median rates of return) that can give a definitive exit point if the stock doesn't live up to expectations.

I have no illusions that this will completely remedy my investing flaw, but it will help. Hopefully, this confessional will encourage you to do a similar audit of your own investing methodology and make you a better investor.

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Tyler Crowe owns shares of Seadrill. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.