Some lessons from my first 20 years as an investor (Part 1)

I would like to say that the last 20 years have flown by, but they haven’t. I started investing in 1995 and to be honest that feels like several lifetimes ago.

Over the years I have made a huge number of investment mistakes and as a result, I have learned many important lessons. Of course, I would prefer to have avoided these mistakes and simply learned the lessons by reading about the mistakes of others.

And so, in the spirit of “passing it forwards”, here are some of the most important lessons I have learned during those first 20 years.

A word of warning though: These are my lessons and they relate to my personal quirks and preferences, but I suspect that they will be at least partially relevant to you too.

Lesson #1: Start slowly and with much caution

Hopefully, you wouldn’t perform brain surgery on yourself, in the dark, having only read a chapter or two of Haynes’ “DIY Guide to Brain Surgery” (no, that’s not a real book, but perhaps it should be).

So why do so many novice investors leap headfirst into the minefield that is the stock market, as I did in 1995?

As a sprightly 23-year-old, I finally had a job that paid a decent wage (I was working as a security guard, which is a good job if you want to have some interesting stories to tell your grandchildren) and my wife-to-be wanted to buy a flat.

We needed a 5% deposit and so with my newfound disposable income, I started to save.

Somehow my research into the best savings accounts led to thoughts about pensions, and from that, I somehow decided that putting at least some of the savings into a stocks and shares ISA was a good idea.

My opinion at the time was that the market was efficient and that stocks were for long-term investors. As my stock market investments would be for a pension which wouldn’t be drawn upon for 30 or 40 years, I chose to invest 100% into a FTSE All-Share tracker.

That sounds simple enough, and for the five years leading up to the year 2000, I was a very happy investor. It was of course the era of the dot-com bubble, and the All-Share just went up and up and up. Over those five years, the market went up by more than 100% and so I smugly patted myself on the back for my obviously brilliant decision to invest.

However, by 2003 the market had fallen 50% from its previous highs and was more or less back at its level from 1995. Not only had the market gone nowhere for eight years, but I had also suffered the emotional rollercoaster of feeling like a nouveau rich genius one minute, and an (almost) penniless idiot the next.

My incredibly stupid but fairly typical reaction to this was to get out of the market in early 2003, selling every unit of my FTSE All-Share tracker and bathing in the warm, comforting “safety” of cash.

Of course, the market then immediately proceeded to turn around and within a year had produced a 40% return, but by that point, I wanted no part of what appeared to be nothing more than a demented casino.

So my first decade in the market almost perfectly mirrored the rise and fall of a successful but basically talentless popstar who is thrust into the limelight and worshipped for a brief moment, only to be the butt of a million jokes and a homeless drug addict the next.

What should I have done instead?

If I had read even the most basic of articles about asset allocation I probably would have invested in a mix of asset classes rather than going 100% into equities. If you cannot stomach the occasional 50% decline then investing everything in the stock market is madness.

With hindsight, I should have invested 50/50 in global indices of stocks and bonds and annually rebalanced the portfolio back to that split if it drifted away. That’s more or less the approach detailed by Lars Kroijer in his book, Investing Demystified (you can find some of Lars’s articles on the Monevator website).

The lower volatility of that portfolio would probably have allowed me to stick with the approach for the long-term, rather than selling at the bottom of the bear market in 2003.

A 50/50 portfolio would also have produced smaller gains than the All-Share between 1995 and 2000, and so my head would not have become as swollen by success as it did.

Lesson 2: If your investment returns are exceptional you are not a genius, you are just lucky

During that 1995 to 2000 period I thought I was a genius for deciding to invest in the stock market.

I didn’t know much about the historic long-run rate of return from equities, so I thought the 20% annual returns from that period were sustainable and that I could just sit back and get 20% a year forever.

In no time at all I’d be (relatively) rich and financially independent. I sort of wanted to race at Le Mans by the time I was 40, and 20% a year returns until then would fund that ambition nicely.

But of course, it didn’t work out quite like that. I was not a genius. I am not a genius. I was just a “lucky idiot”, as Taleb would put it (in his book, Fooled by Randomness).

What should I have done instead?

Instead of smugly feeling like a genius I should have learned that the long-run rate of return on UK equities, including dividends, has been about 5% per year above inflation, or about 7% to 8% given the rate of inflation at the time.

I should have realised that 7% of the returns I was getting each year was down to my decision to invest in equities, and the remaining 13% annual return was down to good luck.

I should also have known that bull markets are followed by bear markets and should therefore have been mentally preparing myself for a major downturn, rather than gaily skipping through the sunshine of my “success”.

Lesson 3…

After my badly mistimed dash to cash in 2003 I stayed mostly in cash for about a year as I researched this whole stock market investing thing in significantly more detail.

However, the next really big lesson (which I cover in Part 2) came not from the stock market, but from my research into the housing market and my subsequent decision in 2005 to sell the flat we’d bought in 1996.