I learned in my 20s about the dangers of leverage. When you concentrate your positions and you are wrong, you can be really wrong. When you combine concentration with leverage and you are wrong, the consequences can be significant.
In my 30s, I learned the other side of that lesson: When you concentrate your positions and you are right, you can be really right.
But high conviction does not mean you are right. It only means you believe you are right. That distinction is important. Concentration can be viewed as an offensive strategy focused on maximizing potential returns, while diversification serves as a defensive strategy designed to help manage risk.
Over the years, many of my most important investing lessons have come from the many mistakes I have made.
Focus on avoiding significant losses. Many great investors emphasize making fewer mistakes because they think winners tend to take care of themselves. A 50 percent loss requires a 100 percent gain just to get back to where you started. I try to stay disciplined, keep emotions in check and focus on rational decision-making.
- Be intellectually honest. This may be one of the most important qualities an investor can have. It is the only way to truly learn and grow from your mistakes.
- Beware of fear of missing out. The FOMO on potential opportunities is never a good reason to invest.
- Look for quality, value and growth. We focus on three key qualities when evaluating a business: quality, value and growth. Quality comes first — we look for proven companies with something special and durable, or some may say “wide moat,” and profitability or a clear path to it. We also want the ability to grow over time. But even a great business can be a poor investment at the wrong price, which is why valuation matters.
- Consider the bigger picture. Don’t fight the Fed. Investors are often described as either top-down or bottom-up, but I have learned that both perspectives matter. Interest rates, inflation and the broader economic environment can influence investment results.
- There is nothing wrong with holding some cash. I tend to be early when buying, and I have learned that patience can be valuable. Cash provides flexibility to take advantage of future opportunities if you remain open-minded and opportunistic.
- Know what you understand — and what you don’t. One of my weaknesses has been fearing I will miss a great opportunity instead of focusing on what I already know. Some businesses are relatively easy to understand and predict. Others are not. Sometimes the best decision is simply to pass.
When I look back at my investing mistakes, more than 90 percent have fallen into two categories: value traps and growth traps. Value traps appeared inexpensive but were not necessarily great businesses. Growth traps were speculative companies where I placed too much confidence in growth expectations that had not yet been proven.
There is also a difference between patience and stubbornness. Patience means giving a sound investment thesis time to play out. Stubbornness is refusing to admit when the facts have changed or when you were simply wrong.
You do not have to repeatedly do brilliant things to achieve good results. Sometimes the most important thing you can do is avoid doing foolish things, learn from your mistakes and invest in what you understand: proven, outstanding businesses. Its good to reflect on your mistakes and learn, grow and improve. ●
Umberto P. Fedeli is President and CEO of The Fedeli Group
