I like to spend a lot of time and effort analyzing the mistakes of Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) CEO Warren Buffett (Trades, Portfolio) and other famous investors.
I do not do this because I enjoy reveling in the errors of billionaires or seeing these wealthy individuals lose money.
Rather, I do it because I believe there is far more we can learn from mistakes and errors than successes. Everyone makes mistakes; it is just part of life.
Learning from mistakes
Investors are particularly susceptible to making mistakes because the world of business and capitalism is so incredibly brutal. Something we may have thought looked like a great idea five years ago may no longer be so attractive today.
Unfortunately, there is nothing we can do about the business environment and the economy. Investors are just objects floating on the macroeconomic sea. All we can do is try and predict the future and ride the current. If we find out we have made a mistake or taken the wrong path, we have to analyze our errors and look to move forward in a different direction.
I believe Buffettâs ability to analyze where he has made a mistake and move on from it is one of the main reasons why he has become such a great investor.
He has made numerous mistakes over his career, but every single time he has acted to blunt the error before it becomes terminal. Buffett has taken the loss and moved on rather than doubling down or getting angry at the market. This is something every investor needs to know and understand.
It is never going to be possible to avoid every mistake. We have to know how to react to mistakes in the best possible way to achieve the best results over the long term. This requires a great deal of emotional intelligence and humility; we have to be prepared to admit when we are wrong, change course and take a loss when we are incorrect about a company's prospects.
Moving on from past errors
One of the reasons why Buffett has been so successful at moving on from ideas is because he has what has been described as a plughole brain. If an idea or a principle turns out to be incorrect, he lets it go down the plughole and never thinks about it again. This is an impressive psychological trick.
One of the reasons why investors tend to make mistakes is they let an idea run wild in their head. They compound it in their minds so much that it becomes the only thing they can think about. This can drive mistakes and cause us to make irrational decisions.
To overcome this issue, we need to seek out different opinions and ideas and not let one idea take over our minds. Of course, that is easier said than done, but Buffett's approach is one hack we can try and make use of.
Another strategy I like to use is the âwould I buy it todayâ strategy.
The approach involves going back and looking at an idea to try and break it down knowing what I do today. I want to understand if I would buy it today knowing what I know about the company and looking at its current valuation.
If the answer to this question is no, then I definitely have to re-evaluate the idea. However, if the answer is yes, then I may add to the position or continue to hold it.
The critical component of this strategy is an unbiased fresh approach. I cannot come into the valuation having any preconceived ideas as that would only influence my outcomes.
Of course, it is never going to be possible to remove all preconceived ideas if I already own stock, but just by knowing that psychological bias can creep in, it is easier to prevent it from having an impact.
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