One common error that many investors make is holding on to a bad idea for too long. You’ve probably heard the phrase, ‘Throwing good money after bad,’ and in investing this applies in spades. Take the example of Michael Pachter, a technology stock analyst, and his opinion on Netflix. Back in 2005 he wrote an article recommending to sell Netflix, and buy Blockbuster. You don’t need to be an expert in securities history to know how that pick turned out. Netflix has risen to be a staple of entertainment in most homes, while Blockbuster has gone bankrupt. And yet, Pachter still to this day, despite the fact that Netflix has earned 4600% in the 12 years since he started coverage, has yet to change his tune, and still expects Netflix’s stock to drop by over 50%. Unfortunately, for many in the public eye, once you have an opinion, it is difficult to bring yourself to admit that you were wrong.
Admitting that you were wrong can be viewed both internally, and externally as a sign of weakness. However, it is actually a sign of great strength and intelligence. It displays that you are willing to listen to new ideas, and not be beholden to your own ego.
Another interesting example is that of Eugene Fame. Fama developed the Efficient Market Hypothesis (EMH), which basically states that asset prices reflect all information (public and private), therefore they are the most accurate indicator of an assets true value. One of the tenants of EMH, is that asset bubbles don’t exist. How could they? Since the asset prices have to be the true value of the asset itself.
Since Fama has published his work, there have been many studies and oddities which have shown the EMH to be less than perfect, to say the least. Take for example, the example brought to him by Richard Thaler, the great Behavioural Economist.
“There’s a closed end mutual fund that happens to have the ticker symbol C-U-B-A. Now, closed end funds have been studied for many years. They’re a special kind of mutual fund where their shares trade on markets and the price of the shares can deviate from the value of the assets that they own. So this particular fund, although it has the ticker symbol CUBA, of course cannot invest in Cuba. A) that would be illegal and B) there are no securities. So its holdings of Cuba are zero. And for many years it traded at a discount of about 10-15% of net asset value. Meaning that you could buy $100 worth of the assets for $85-$90 which was a good bargain. Then if we look at the chart, all of the sudden one day the price sky rockets and it sells for a 70% premium and you could probably guess what happened. That was the day president Obama announced his intentions to relax relations with Cuba. So a bunch of securities you could buy for $90 on one day cost you $170 the next day. Now that I call a bubble…..I’m pretty sure Gene doesn’t think it’s smart to pay $170 for cruise ship lines and Mexican companies. And all through this period there was no change in the value of their assets.”
Despite being presented with this (and other examples), Fama still cannot bring himself to admit that bubbles exist, and that irrationality can dictate asset prices. This is not to knock Fama, he is a very accomplished and intelligent professor. However it highlights just how difficult it can be to publicly admit that you were wrong. It gets wrapped up in who you are as a person, and to do so would be to question your very existence. Yet we must, otherwise you begin to live in an alternate universe, one that is detached from reality. And that is when we make bad decisions.