No. of Recommendations: 4
In an admirable attempt to get back to its roots TMF has been running articles on investing basics. Today’s column, though awkward entitled, Our Analysts' Most Embarrassing Investing Moments, makes for an hugely informative read, because it’s mistakes that offer the best investing lessons. Predictably, all of the columnists’ anecdotes are stock-related. So I’ll offer one of my own from bonds.

2007 was a tough year to find yield, and the banksters’ bonds were pretty much the only ones that offer it. So week by week, for not finding much that seemed better, I let myself become overweight (singly and collectively) BofA, Bear Sterns, Citigroup, Countrywide, Goldman Sachs, Lehmans, Morgan Stanley, and WAMU. Well, you know as well as I what happened. The Fed/Treasury cartel (i.e., Goldman Sach’s foreign office) threw Lehmans under the bus and bailed out everyone else.

Generally speaking, there isn’t anyone’s bonds that I won’t buy one of when its yield is attractive. But there’s a world of difference between screwing up on a position that is 1/5th of 1% of AUM (assuming a mid-sized $500,000 account and a single bond bought at par) and putting on a position that amounts to 5% of AUM and/or an industry exposure as much as 10% of AUM.

As a fraction of assets under management, my position in Lehman’s debt was 5.3%. But it shouldn’t have been even half of that, not given the fact that I was also holding the bonds of its peers. Not all of what I held of Lehman’s debt was bought near par, but even a reasonably-acceptable Chapter 11 workout of $0.23 on the dollar makes for a huge loss that should never have happened.

But that’s not the worst. I became so panicked about keeping my exposures down to manageable sizes, that I began committing the opposite (though more survivable) mistake of under-weighting positions. To cite just one example, in 2009 I went long just a single of Hanson’s 6.125’s of ’16 (rather than the five that would have been prudent for my account size), and I lost out on the opportunity to capture as much of its 11.5% CY and 21.4% YTM as I should have. And for much of 2010 and 2011, I also under-weighted my positions, though this year, a tough year to be buying bonds, I've gotten myself back into a more balanced pattern of buying (nearly 90 new positions, properly sized according to risk and exposure, with an average YTM around 10%.)

Yes, in retrospect, it’s easy to look back and say, “I should have bought more”, or “I should have bought less”. But this much can and must be done. At the time a position is being put on, one has to see everything that should be seen. If, subsequently, the trade doesn’t work out, then it is still a good trade, because it was done according to plan.

OTOH, if you put on a position that you should have seen was a mistake, but the market bails you out, you ought to kick your butt up and down the hall for breaking your rules. That’s what's truly embarrassing. You knew better, but you made the mistake anyway.

Plan your trades, and trade your plan.
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When Life Gives You Lemons
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