Two mistakes I’ve made you can avoid

By Bob Peters || October 7, 2021

Everyone makes investing mistakes and I’ve made my share.  Let me share two mistakes I’ve made that you can avoid.  Before I go into some detail the themes of these mistakes include:

-Partial knowledge can trick your brain into thinking that you are investing when, in fact, you are speculating.

-Don’t rely on a friend’s advice as a substitute for rigorous analysis.

-Even though you may have studied Accounting and Finance, without rigorous analysis, you can be overconfident in your conclusion.

-Investing Wisely requires diversification. 

-Your emotions will want to prevent you from Investing Wisely.  By knowing how your emotions work, you can avoid these mistakes.

The amount of work required to understand intrinsic value is more than most of us can and will do

In 1991, one of the largest and oldest US banks, Bank of New England, failed and was liquidated in a Chapter 7 bankruptcy.  I thought I was investing $2,000, rather, I was speculating and lost 100% of my money.  Even though I was trained in accounting, finance and worked for a bank I did not do the amount of work required to understand intrinsic value.  The amount of work required to understand intrinsic value is more than most of us can and will do.

The failure of the Bank of New England was, at the time, the 3rd largest bank failure in US history.  From 1983-1988, the US economy was growing and the economy in the Northeast was growing even faster.  The CEO of the bank was aggressively looking to grow the bank’s market share as he believed that a larger bank would be more valuable.  Residential and Commercial real estate values in the banks’ region were increasing at a rate higher than the national average which gave the CEO confidence of growing its exposure to real estate loans with a heavy reliance on construction lending.

The economy began to deteriorate in 1989, due to the CEO’s aggressive desire to grow loans the bank had increased not only the amount of real estate loan exposure but also increased the exposure to single borrowers.  As the economy contracted, the quality of the bank’s loans deteriorated.  Borrowers went into default and the regulator took over the bank.

In 1987 I had completed a commercial banking training program and had a job where I was a junior banker doing credit analysis.  Shortly after assuming this job the economy went into decline and the value of Bank of New England shares declined.  A colleague told me that his brother, who worked at the bank, believed that they were going to survive.  I did not understand the concentration of loan risk which would have been necessary to determine intrinsic value.  Instead, believing that I could buy the stock cheap, I bought the stock and lost all of my money.

Lessons from Bob’s Bank of New England mistake

There are many lessons learned from Bob’s Bank of New England mistake.

Although I was young and relatively inexperienced as a credit analyst I was better equipped than most people to perform some level of analytical rigor on the bank and the industry.  I could have read the FDIC Call Report, reviewed the financial statements and studied the public filings.  I did not do any of that.  Instead, I saw a big drop in the stock price and placed way too much reliance on a friends brother’s view that the bank would survive.

I had mistakenly ascribed too much emotional value to the fact that it was one of the largest and oldest banks in the US and, incorrectly, believed that the regulators would not allow it to fail.  My brain told me that I was “investing” when I was actually “speculating.”  The concept of understanding the intrinsic value of the company was never considered. 

A good Education did not protect me from poor Behavior.  

Emotion and a “Desire to Believe” blinded me

Many years after the Bank of New England mistake (and more than a few since), I let my partial knowledge and emotion win again.

I had joined Bank of America in 1985 as my first job after graduating from college.  By 2006 I had performed well and was given greater responsibility overseeing larger, more valuable relationships and was asked to manage the regional commercial banking team.  My team was experienced.  I respected my boss.  The economy had been performing well.  The stock price had more than doubled over six years.  I felt good about my 19 year career with the company.  To top it off, I had an emotional tie to the company as my great grandfather had worked for Bank of America for 43 years.

I was too concentrated in my exposure to the company.  My employment and the percentage of my investable assets was beyond what just about any reasonable financial advisor would suggest was prudent.

The stock price of Bank of America reached an all-time high of $54.90 in November 2006.  By March 2009 the stock closed at $3.14.  Along the way I did not sell any of my shares.  I had a Desire to Believe.  My confidence in the business risk of the unit where I had direct responsibility blinded me as to the degree of risk that existed in company.  While the passage of time did prove me right on my units’ business risk it likely contributed to my over optimism.

I would encourage everyone to seek employment where you feel passion and where you have a Desire to Believe.  Believing in the mission of the work gives you the “Why” you do the work that you do.  What you should not do is let the Desire to Believe cause you to deviate from Investing Wisely.  Investing Wisely is done by purchasing a low cost, diversified exchange traded fund that gives you a very broad exposure to many businesses.  You do not need to study Accounting or Finance.  You do not need to do an industry analysis to assess the competitive position of a business.  You do not need to do a rigorous Intrinsic Value Analysis.  

Lessons learned from Bob’s Bank of America mistake

While I had confidence in the risk profile of my own business unit I lacked knowledge about the banks’ residential mortgage business, the massive contingent liabilities and just how devastating the Great Financial Crisis would be to the economy.  I read some publicly available equity research reports but I did not perform an independent rigorous intrinsic value analysis. I let my emotional connection to the company blind me from a critical view of the competency of the bank’s leadership team.

A good Education, better than average knowledge of the company, financial analysis acumen and a Desire to Believe did not protect me from poor Behavior.  A Wise Investor would have had less exposure to one stock. A Wise Investor would not allow himself to buy a stock without performing an intrinsic value analysis.  The amount of work required to understand intrinsic value is more than most of us can and will do.  Even with knowledge of the industry and Accounting and Finance experience, my emotion was not kept in check and I failed to do a rigorous Intrinsic Value Analysis.

Being a Wise Investor is simple if you understand how Behavior can derail us.  I hope by sharing these mistakes, you can avoid making similar ones.  Good luck.

A final note about Intrinsic Value Analysis:  With some accounting and finance background it sounds easy enough to do.  You simply assign some probability to discounting future cash flows of a business.  What is really difficult to do is to pierce far enough into the business to understand the risks.  In the case of Bank of New England, public documents gave a rear view mirror look into the quality of the loans.  What was not readily available was seeing the quality of the new loan originations.  The seeds of failure were sowed long before the publicly available data showed deterioration as loans to individual borrowers started to increase and loan concentrations grew in areas of lending that had high risk characteristics.  Any intrinsic value analysis on Bank of New England would have needed to rely on the rear view mirror look which makes it a weak analysis at best, particularly when the strategy of the bank was to grow aggressively.