A common misconception in investing is to put money into heavily discounted stocks, or invest in raw land on the outskirts of a fast-growing city. Investors reason that cheap stocks will certainly rebound strongly eventually, and buying a fully discounted property means that it can only go up go up in value.
What flaws are there in this forecasting approach?
Timing is crucial
Even if this assumption ends up on target, the timing may be off by years or even decades. Being correct but way ahead of your time often ends up producing the same results as being wrong: terrible returns or even losses. Timing matters, sometimes even more than the quality of insight. Therefore, contrarians and creative thinkers need to strongly consider not just if they’ll be right, but when they’ll be right. Many investors, entrepreneurs, and inventors have learned this lesson the hard way.
Say these cheap stocks indeed double or even triple in value. Investment success is measured within the context of time (and its effect on compounding.) If compounding only happens over many years, the investment can’t be judged a success. Consider that doubling your money over 10 years is about a 7.2% return, as is a tripling over 15 years. Those numbers are OK, but not commensurate with the risk of a lack of diversification and the significant effort undertaken. What if you’re wrong and some of your unique selections go bust?
But even if you’re not wrong, markets can stay irrationally underpriced even for decades, making a tripling of returns meaningless after inflation. And often “early” investors lose their patience and conviction while waiting and lock in their losses rather than hanging around forever for a payoff.
A golden example
One example of a potential investment that took decades to grow is gold. This was after the metal’s price exploded by 500%, shooting from roughly $150 to $750 per ounce between 1977 and 1979. Once the “stagflation” (stagnation + inflation) panic eased, gold’s value fell quickly back down to $300 per ounce. Let’s say Mr. T decided to buy gold after it fell by a third to $500 per ounce. Not only did he quickly suffer significant losses as gold continued falling, but he also didn’t see the growth he was anticipating for over 25 years! Would Mr. T have had the stomach to roll with the punches for that long? Even if he did hold on and cashed out at a peak of $1,800, his annualized return was below 5%, less than what cash in the bank made back then. Meanwhile, government bonds grew by 8.6%, and stock mutual funds gained 11.1% annually. Some metziah!
When it blows
Even if the early contrarian is confident they’ll be proven right and that the payoff is worth waiting for, often their hands are forced. Will you be able to fund many years of property taxes to keep your land? If not, you may lose your property before the growth enables you to cash out. Things get dicey when there are loans or other substantial overhead involved in a too-early investment. A new building or development that hits the market at the wrong time often ends up in bankruptcy, wiping out the visionaries. Even if the project is ultimately wildly successful as predicted, banks and vendors don’t wait around. If sales and leasing don’t proceed apace, foreclosure sets in, and the (belated) investors who scoop it up make the big bucks!
Being too smart
John Maynard Keynes (1883–1946), a famous economist and investor, said, “The market can stay irrational longer than you can stay solvent.” Even if you’re brilliantly correct in theory, you can’t always wait around for the market to catch up to your prescient perspective. Beyond investing, genius inventors and creative entrepreneurs can easily bankrupt themselves pursuing visions before the technology or marketplace can support them. For example, electric cars, solar batteries, computer tablets, and mp3 players failed as inventions until the materials required to build them functionally came around. The glory and profit go to the one who executes, not the one who conceives. This fact is why people often quip, “Besser mazal vi seichel”—It’s better for business to have good mazal than good brains.