You are not as smart as you think you are

Today I am going to share a small excerpt from my first book, Active Value Investing. This book came out in 2007, and then a few years later I rewrote it into a more compact and accessible book, The Little Book of Sideways Markets. I still stand by every word I wrote in this essay, but the older, more mature Vitaliy has new, hopefully more nuanced thoughts to share in the “additional thoughts” that follow this essay.

Lately, I’ve been getting this powerful feeling that everything I touch turns to gold. Every time I buy a stock, it goes up. Did I finally figure out the stock market game? Did I find a secret way to follow Will Rogers’ advice: Buy stocks that go up, and if they don’t go up, don’t buy them?

No, I didn’t get much smarter, and my stock-picking skills haven’t improved that much over the past year. I was simply a willing participant in the latest (cyclical) bull market. A bull market makes you feel smarter than you are, the same way a bear market makes you feel dumber than you are.

Feeling smart makes you do the opposite of what you should be doing. The euphoria of the golden touch is a dangerous thing because it can make us careless. We forget about risk since we haven’t seen it in a while and focus only on the rewards. You have to actively make yourself aware of the four-letter word R-I-S-K!

How do you do that? My favorite way is to remind myself how dumb I am. I pull out an annual return report of a company on which I lost a boatload of money and masochistically try to read it from cover to cover, reliving my errors.

We all have these stocks, the ones we lost a lot of money in. We tend to forget about them during a bull market. But I suggest you remember them now, so you’ll have fewer of those names to remember in the future. Risk is still there; it is just hiding under the joyful sentiment of the bull market.

It will show its ugly face. It is just a matter of time.

Discipline counts

In a bull market, it is easy to forget about selling discipline and then turn into a “buy and forget to sell” investor. Every time you sell a stock, you look dumb because it usually goes up afterward.

I recently sold several stocks, shamelessly, paying absolutely no attention to the fact that after I sold, they went higher. I don’t feel smart about that decision. However, when I bought those stocks, I set valuation targets. When they approached the targets, I quickly reviewed their fundamentals. They had not changed much. The decision was obvious: sell.

Cyclical bull markets teach us not to sell, while cyclical bear markets teach us not to buy. If you let the market tell you what to do, you have no process.

But the bell doesn’t ring when bull or bear markets are over.

You cannot worry about marking the “top” in every sell. My objective is not to buy at the “bottom” and sell at the “top.” My objective is to buy a great company when it is cheap and to sell it when it is fairly valued! I suggest you do the same.

Additional thoughts: I want to make a nuanced but very important point here. I am not advocating for timing the market, but I am arguing for being rational, not letting the market make decisions for you. Don’t get intoxicated on the market’s euphoria.

It is very difficult psychologically to sell and see the stock you sold go higher. It is also difficult to be underinvested (hold cash) when the market keeps marching higher. You want to make rational decisions and not let the market make decisions for you. These decisions are usually hard, because you feel lonely when you make them.

I have learned that the right decisions usually come with a certain amount of discomfort, and for good reason: you are making them against the grain of the market. Selling when everyone else is excited and enthusiastic, when everyone feels like the sun will shine all the time for the rest of eternity and clouds are a thing of the past, is incredibly difficult.

The same is true when buying while everyone else is selling. It must be part of our evolutionary programming: We found comfort and safety going hunting as part of a tribe, having physical and emotional support from other members of our pack.

In investing, this comfort comes at a significant cost. You want the other members of the tribe to agree… but later. I just tell myself I am doing what everyone else is doing, just a bit earlier.

Key takeaways

A bull market makes me feel smarter than I actually am—my returns come from the rising tide, not from any sudden leap in my stock-picking skill.
When everything I buy goes up, that’s my cue to think harder about risk, not less. Risk doesn’t disappear in good times; it just hides under the euphoria and waits.
My favorite antidote to overconfidence is masochistic: I pull out the annual report of a company I lost a fortune in and relive every mistake, so I stay humble.
I refuse to let the market make my decisions for me. I set valuation targets when I buy, and when a stock reaches fair value and the fundamentals haven’t changed, I sell—even if it climbs higher afterward.
The right decisions almost always come with discomfort, because I’m making them against the grain of the crowd. I’m just doing what everyone else will do eventually, only a little earlier.