Investors don't just exist in the present state, they carry past experiences with them. This is dangerous because it leads us to constantly draw parallels where none exist. Looking at each decision independent of previous ones would be beneficial because investors are overly reliant on past experiences when thinking about future scenarios. To test this hypothesis, a team of researchers studied brain‐damaged individuals with normal IQs. The parts of the brain responsible for logic were intact, but the areas responsible for emotions was damaged, which limited their ability to experience ordinary feelings such as stress, regret, and anxiety. The Wall Street Journal reported on this link in 2005:
The study suggests the participants' lack of emotional responsiveness actually gave them an advantage when they played a simple investment game. The emotionally impaired players were more willing to take gambles that had high payoffs because they lacked fear. Players with undamaged brain wiring, however, were more cautious and reactive during the game, and wound up with less money at the end.3
Even if we were told that a loaded coin would land on heads 60% of the time, seeing four tails in a row would alter some people's decisions, despite knowing that they should bet on heads every single time. “If you just observe these people, they know the right thing to do…. But when they actually get into the game, they start reacting to the outcomes of the previous rounds.”
Humans come preprogrammed with something called hindsight bias. It's a defect in our software that falsely leads us to believe we knew what was going to happen all along, when in reality we had no clue. Hindsight bias leads to regret, and regret leads to poor decision making. Regret steers our brain in two distinct ways: We do nothing out of fear that we'll make the wrong decision. “I'm going to hold onto this fund that's done horribly because I can't stand the thought of selling at the bottom,” and it can compel us to do something because we don't want to regret not doing it: “I'm going to buy this ICO (initial coin offering) because I won't be able to live with myself if I miss the next Bitcoin.”
You know Steve Jobs and his early partner Steve Wozniak, but the name Ronald Wayne likely means nothing to you. Wayne was the third founder of Apple, but the reason his name is erased from the history books is because in 1976 he sold his 10% stake in the company for $800.4 Apple is currently worth north of $900 billion! You're never going to experience anything quite this painful, but the odds are high that at some point in time, you'll pass on an investment that goes on to deliver fantastic results. You cannot avoid regrets in this game. You'll buy stuff you wish you hadn't and sell things you wish you held onto. We can learn all about regret by studying one of the most successful investors of all time, Chris Sacca, who has arguably left more money on the table than anyone in the twenty‐first century. There are only eight private companies currently valued at 10 billion or more. Chris Sacca passed on two of them.5
A 10‐bagger is an investment that multiplies an initial investment 10 times. Most investors won't be lucky enough to find this needle in a haystack, but even if they do, most will lack the discipline to ever turn $1 into $10. It's extremely difficult to watch something that has gone up so much without feeling (a) greedy and (b) that the gains will be ripped away from you. While 10 baggers are the unicorn in public markets, in private markets, especially at the early stage, thousand baggers exist. Chris Sacca and his investors have experienced this perhaps more times than anybody in the history of private or public investing.
Sacca is the founder and chairman of Lowercase Capital, an early stage venture capital fund. In a conversation with Tim Ferriss, Sacca said his first fund “might be the most successful fund in the history of venture capital.”6 With returns of 250 times their original investment, his early investors hit the mother lode. Having your money grow 250 times is an incredible accomplishment. For comparison, in order to have earned a 250 times return on your investment in Apple, one of the best‐performing stocks of all time, you would have had to buy the stock all the way back in February 1998!
Sacca became a billionaire in under 10 years and before the age of 40 because he is an expert at spotting unicorns, private companies that have reached the $1 billion valuation mark.
Lowercase Capital was one of the first investors in Uber, putting $300,000 into the concept. Recently, it owned as much as 4% of the company, giving the fund a 5,000 bagger.7
Some of Sacca's other home runs include Instagram, Uber, Kickstarter, Slack, Automattic (WordPress parent company), Twilio, and most notably, Twitter. By the time of the initial public offering, he and Sacca's funds had accumulated 18% of the company. He originally invested in Twitter at a $5 million valuation,8 and it's currently valued at $15 billion, giving Sacca a 3,000 bagger. His Twitter investment has reportedly returned an astonishing $5 billion for his investors.9 Sacca invested in Instagram's Series A at a $20,000,000 valuation,10 which was later purchased by Facebook for $1 billion, giving Sacca “only” a 50 bagger.
Sacca has four rules of investing, which he shared on The Tim Ferriss Show podcast:
He must know that he can have a direct and personal impact on the outcome.
The investment must be excellent before he gets involved. Sacca looks to make good things better. He doesn't try to fix something that's not good to begin with.
He allows time for a deal to make him rich.
He selects deals he will be proud of and commits to them.11
Even an investor with a process and fantastic returns doesn't go to sleep without a few regrets. Sacca has had the opportunity to invest in some of the most successful start‐ups of the twenty‐first century. Many he jumped on and regrettably, others he passed on.
Sacca met Nick Woodman, the founder of GoPro, while he was working at Google. He didn't have his fund at the time, but he would have passed on investing if given the opportunity. He told Tim Ferriss the story: “Eric Schmidt, CEO of Google said, ‘Hey, will you come in here and sit with this pitch? A friend of a friend said we gotta meet this guy.’ Woodman comes in with GoPro and Eric's like ‘I don't know,’ and I was like we'd be foolish to do this deal. How's this guy from Santa Cruz gonna compete with all these Asians building hardware? You can't hold a candle to the Taiwanese and the Koreans. I was like no dice man, let this guy go.” GoPro went public in 2014 at a valuation just below $3 billion.12
He didn't have the chance to invest in GoPro, but Sacca said no to some of the most well‐known and storied businesses of the decade. “One of my constant recurring nightmares is about the stuff I passed on.” He tells a story about the time he met with Dropbox, whom he met while they were still in Y Combinator's early‐stage start‐up program. He didn't think they could beat Google, which was developing its own file‐sharing service, Drive. He went so far as to recommend that Dropbox pursue a different path. Lucky for Dropbox, they didn't take his advice. Sacca estimates his decision to not invest in Dropbox cost him “hundreds of millions of dollars.”13 At close to a $10 billion valuation, Dropbox is one of the biggest misses of Sacca's career.
Chris Sacca spoke to Bill Simmons about another miss – passing on Snap, the parent company of Snapchat. At the time, Snapchat was widely considered to be an app ideal for sending photos that are not safe for work. Images sent on Snapchat (called Snaps) automatically disappear seconds after they are viewed. Snap continued developing new functionality, so today users can create Stories, a series of photos that don't disappear. Sacca couldn't see Snap's potential and passed.14 Now, Snapchat functions like a full social media or messaging app, and it has a huge user base, especially among Generation Z. Snap went public in 2017 at a $24 billion valuation.15 Ouch.
When Simmons asked, “Is that your biggest misfire?” Sacca responded, “I misfire all the time. I told the Airbnb guys what they're doing is unsafe and somebody was gonna get raped and murdered in a shared house.”16 Airbnb is currently worth more than $30 billion.17
Sacca is able to speak openly and candidly about his misses because he's had so many winners. He understands that swin
ging and missing, or in these cases watching the pitch and not swinging is part of the game. For us mere mortals however, passing on the next Amazon, or selling it too early can have disastrous and long‐lasting effects, because for us, these opportunities don't come around too often. Sacca is able to look at these missed opportunities and move on, whereas most people would be left with a giant scar.
Regret is highly correlated with emotional extremes, and emotional extremes happen when you have either big embedded gains or losses. You put $10,000 into a stock, and it doubled, now what? You're afraid that if you sell you'll leave money on the table and also that if you hold it, your gains will evaporate. You put $10,000 into a stock and it got cut in half. Now what? If you sell, you know that will mark the low, but if you hold, who knows how low it can go? Whenever I speak to somebody in this position, I always ask this question: What would feel worse – you hold onto the stock and it gets cut in half, or you sell it and it doubles again? Neither of these would feel too great, but holding onto a stock and watching all the gains disappear is more mentally straining than locking in gains only to watch the stock go higher. It's easy to tell yourself that you were just being prudent, that it would have been irresponsible not to sell. It's hard to tell yourself that you held onto a stock that doubled because you thought it would double again.
We can't know what the future holds, so it's crucial that we minimize regret. Harry Markowitz who practically invented modern portfolio theory once spoke about how regret drove his own asset allocation: “I visualized my grief if the stock market went way up and I wasn't in it – or it went way down and I was completely in it. My intention was to minimize my future regret.”18
The best way to minimize future regret when you have big gains or losses is to sell some. There's no right amount, but for example, if you sell 20% and the stock doubles, hey, at least you still have 80% of it. On the other hand, if the stock gets cut in half, hey, at least you sold some of it. People tend to think in all or nothing terms, but it doesn't have to be that way. Thinking in absolutes is almost guaranteed to end with regret. Minimize regret and you'll maximize the chances of you being a successful investor over the long term.
Notes
1. VW Staff, “Michael Mauboussin: What Have You Learned in the Past 2 Seconds?,” ValueWalk, February 6, 2015.
2. J. P. Morgan, “Guide to the Markets,” November 30, 2017.
3. Jane Spencer, “Lessons from the Brain‐Damaged Investor,” Wall Street Journal, July 21, 2005.
4. Jessica Chia, “Apple Co‐founder Who Sold His 10 Percent Stake for Just $800 Has Never Owned Any of the Company's Products and Insists He Doesn't Regret a Thing,” Daily Mail, July 13, 2017.
5. Scott Austin, Chris Canipe, and Sarah Slobin, “The Billion Dollar Startup Club,” Wall Street Journal, February 18, 2015.
6. Chris Sacca, interview with Tim Ferriss, The Tim Ferriss Show podcast, October 29, 2015.
7. Jillian D'Onfro, “Investor That Owns 4% of Uber ‘Barely Speaks’ with Uber's CEO,” Business Insider, March 25, 2015.
8. Crunchbase, “Series A – Twitter,” December 2017.
9. Yolanda's Little Black Book, “Billionaire Chris Sacca's Baller Real Estate Portfolio,” December 15, 2016.
10. Crunchbase, “Series A – Instagram,” December 2017.
11. Interview with Tim Ferriss.
12. Neha Dimri, “GoPro's IPO Priced at $24 per Share: Underwriter,” Reuters, June 25, 2014.
13. Interview with Tim Ferriss.
14. Chris Sacca, interview with Bill Simmons, “Episode 95: Billionaire Investor Chris Sacca,” The Bill Simmons Podcast, April 28, 2016.
15. Portia Crowe, “Snap Is Going Public at a $24 Billion Valuation,” Business Insider, March 1, 2017.
16. Interview with Bill Simmons.
17. Lauren Thomas, “Airbnb Just Closed a $1 Billion Round and Became Profitable in 2016,” CNBC.com, March 9, 2017.
18. SEI, “Behavioral Finance: Loss and Regret Aversion,” September 2014.
CHAPTER 16
Michael Batnick
Looking in the Mirror
You will do a great disservice to yourselves, to your clients, and to your businesses, if you view behavioral finance mainly as a window onto the world. In truth, it is also a mirror that you must hold up to yourselves.
—Jason Zweig
Earlier in the book I highlighted one of Stanley Druckenmiller's unforced errors; I've committed literally thousands of them. You might think this is hyperbole. It isn't. In 2012, I spent $12,000 in trading commissions. It's hard to believe I was trading that frequently; at the time, I thought I was investing! The following year, I decided to slow things down and focus on the big picture, with a slower, longer‐term approach. I lost almost $12,000 in a year when US stocks rose 32%. I've made almost every mistake in this book.
I have traded individual stocks from Alcoa to Zynga, basket of stocks both domestic and international (ETFs), bonds, currencies (ETFs), and commodities (ETFs). The “thought process” wasn't always the same. I've tried putting all the macro pieces together like John Maynard Keynes and I've tried valuing companies on the micro level like Benjamin Graham. I've been overconfident. I've anchored to my purchase price. I've cut my winners short and let my losers run. I made a lifetime of mistakes and was fortunate enough to do them in a small window of time. It takes some people decades to figure out what works for them, and many just never get there. How was I able to jam pack my failures into just a few years? Let's go back to the beginning.
I wasn't one of those kids who bought their first stock when they were 11 years old. I didn't read the Wall Street Journal in high school, and I didn't build algorithms in my dorm room. In fact, the way I treated education is the biggest regret I have in life.
I didn't take high school seriously, but I got by and did well enough on my SATs to get into a good business school. When I went to college, I was in over my head. I spent a lifetime going through the motions, so looking back, it's not surprising that I wasn't ready, because I did nothing to get ready. I only lived in Indiana, but I didn't actually attend school there. It's amazing what happens to your grades when you don't go to class. I got a 1.2 GPA my first semester and followed that up with a 1.1, which apparently was unacceptable. The higher‐ups told me to take some time off and reapply in a year.
I came home and went to community college for a year. With a little effort, I got my grades up and was accepted back for my junior year. But I still wasn't ready, emotionally or mentally or otherwise, and when I dropped calculus, I was summarily dismissed. This one hurt. In hindsight, there's something not so terrible about hitting rock bottom at 20 years old, but at the time, it was completely humiliating. I came home again and this time it was permanent. I remember sitting in the car with my father, tears running down my face and without any answers for him. He wasn't angry, more like disappointed, which is far worse. I didn't know what I was thinking, and I still struggle to come up with answers.
The reality of my failures hit me hard. For the first time in my life, I was thinking about my future and wondering what it would look like. A year and a half late, I finished college with a degree in economics, but I still had no idea what I wanted to do for a living. My nascent professional career wasn't helped by the fact that it was 2008 and millions of Americans were losing their jobs.
Shortly after I graduated, I got a job at a financial planning company. I felt like the luckiest kid in the world. I had screwed up royally in college and was no worse for the wear. But what I thought I signed up for and what I actually signed up for were two entirely different things. The job was all about selling insurance to anybody you knew and cold calling everybody you didn't know. I did that for about a year and a half, and it was a lousy experience. I was given no salary, was required to pay rent (not a typo), and had no desire to pretend to prepare a financial plan for someone and then use insurance products to deliver the plan. I purchased a policy for my wife and myself, my dad bought something, and t
hat was that. I didn't sell anything else in those 18 months. I was paying for my big mistake, and those tuition payments would continue for a few more years.
While I was at the insurance company, my father introduced me to a real financial adviser. The guy took a liking to me and started sharing sell‐side research reports with me every day. I had no idea what “PIIGS” (Portugal, Ireland, Italy, Greece, Spain) were, but I enjoyed the material and decided this was what I wanted to do. I didn't know exactly what “this” was, but I knew I wanted to be on Wall Street. So I quit my job and decided to get a real education. I spent every day at the library, studying for the CFA (Chartered Financial Analyst) exam, reading finance books, and catching up for lost time. I became obsessed. I was on a mission. I would find my way into the industry come hell or high water. But there were a few challenges I'd have to overcome; my résumé was garbage, the financial world was in free fall, and my mother was dying.
Every day in 2010, I would drive my girlfriend (now wife) to the train station in the morning, and I'd spend all day working. My job was to teach myself about the industry and to one day have something to offer. I passed level 1 of the CFA exam and was feeling pretty good. I was sending my résumé all over the place, but I should have done more. I wish I had the chutzpah to email strangers and walk into branches, but I didn't yet have the confidence to do that.
In 2011, I sat for level 2 of the CFA exam. When I took the test, I said to myself, “How many people in this room have zero industry experience?” For the first time in my life, I was proud of myself. I went from somebody who thought education was a joke to a laser‐focused learning machine. But the test went horribly, and I knew when I walked out that I didn't pass. My mother died a few days later. It was the hardest thing I've ever experienced.
When my mother passed, she left me and my siblings some money. I had already read Jack Bogle's The Little Book of Common Sense Investing, and the idea of an index fund made a lot of sense to me. But I also read Jack Schwager's Market Wizards and the idea of becoming the next Paul Tudor Jones was much more appealing.
Big Mistakes Page 15