Big Mistakes: Overconfidence Can Cost You Millions of Dollars

We are continuing our series on investing. You can see our previous article here.

I bought Michael Batnick’s book Big Mistakes: The Best Investors and Their Worst Investments.

The great value proposition of this book is the mistakes made by great investors such as Warren Buffet and and what we as investors can learn from it.

Lesson #2. How Overconfidence Can Cost You Billions

Imagine you are at a soccer game. To heighten the stakes, you place a wager on the outcome. Once you place your bet, though, you instantly feel confident about your choice. Suddenly a fan approaches you, offering to buy your bet slip for far more than you wagered. Would you do it?

According to many psychologists, it is unlikely you would.

According to what psychologists describe as the endowment effect, we ascribe more value to things simply because we own them. It does not mean our possessions are inherently appealing, but just more difficult to give them up.

The endowment effect illustrates two points.

(1) Objective thinking melts away when we own something.

(2) Our confidence rises once we have made a decision.

We then fall into overconfidence, which can have devastating effects on our investing decisions. What is the lesson? Always assume that you can be wrong!

The Story of Warren Buffett and Berkshire Hathaway

Warren Buffett has had a stellar track record as an investor. Between 1957 and 1969, he managed a partnership that returned gains of 2,610%. In 1972, Mr. Buffett and Berkshire Hathaway purchased See’s Candy for $30 million. Since the purchase, the company generated over $1.9 billion in pre-tax revenue. Having hundreds of success stories, Mr. Buffett was high-flying and oozing with confidence. However, his first big mistake would come in 1993.

That year, Berkshire purchased the Dexter Shoe Company for $433 million. Dexter was an American manufacturer, and it had Mr. Buffett’s complete confidence.

He wrote to his shareholders, “Dexter, I can assure you, needs no fixing: It is one of the best-managed companies Charlie and I have seen in our business lifetimes.”

The legendary investor was so enamored of his new purchase that he failed to see the effects of globalization on the shoe industry that would be coming over the next few years.

Just a year later, Dexter was hemorrhaging cash. The rise of manufacturing in China, Mexico, and Southeast Asia crippled the American domestic shoe market. Feeling confident in his decision, Mr. Buffett held onto the investment. By 1999, Dexter’s revenue had declined 18%. The company ended U.S. shoe production in 2001, and Berkshire merged Dexter into its other shoe companies.

What is the Takeaway?

Mr. Buffett had been on a run of successful deals and failed to be vigilant and change direction when the deal went bad. You should extensively research every company you plan to invest in and always be ready to reassess your investment.

Do not be afraid to sell your position if you have any doubts, EVEN AT A LOSS. You do not want to have a long position in a company when the company or industry starts to free-fall.

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