Why I'm Down More Than 65%, and How to Avoid My Mistakes

In that spirit, I'm writing about my biggest mistake during this bear market. Here. Publicly. For the whole world to see.

After all, if legendary investor Peter Lynch of Fidelity Magellan fame could publicly admit to holding AIG and Fannie Mae at the end of 2008, what's an analyst like me got to lose?

I hope two things come of my story:

1. Someone, somewhere out there learns something from my mistakes. Feel free to consider me a sacrificial teacher.

2. Having studied psychological commitment and consistency in Robert Cialdini's classic work Influence: The Psychology of Persuasion, I hope that my public commitment to avoid repeating these mistakes prevents me from falling victim to them again.

Mea culpa
My greatest investing failure of the past year has been my investment in Allied Irish Banks. To date, I'm down 66% (not long ago, I waved goodbye to more than 90% of my initial investment, but the stock has recently inched upward).

True, it's not quite as big a loss as those suffered by investors in YRC Worldwide (Nasdaq: YRCW), Energy Conversion Devices (Nasdaq: ENER), Eagle Bulk Shipping (Nasdaq: EGLE), Delta Petroleum (Nasdaq: DPTR), and Century Aluminum (Nasdaq: CENX) over the past 12 months, but what consolation is a few percentage points' difference when you've lost 66%?

And yet, painful though that loss is, seeing how avoidable this was in hindsight hurts even more.

Perhaps the only comforting thought is that in Warren Buffett's most recent Berkshire Hathaway annual report, he writes that he also suffered a significant loss by investing in Irish banks. Some have speculated that AIB was among them. So at least I was fooled alongside a much better investor.

Following the crowd
I first went wrong in falling prey to social proof. I put too much weight on the research, opinions, and actions of others, without thinking through my investment decision for myself, and deciding whether it made sense in my portfolio.

Prior to my purchase of Allied Irish Banks, it had been recommended in our Global Gains newsletter service and purchased by the team heading up our real-money Million Dollar Portfolio real-money service. Advisors in both services wrote that the stock was trading with low historical and relative multiples, a very attractive dividend yield, and a significantly undervalued price.

While they made compelling arguments, I failed to carefully evaluate whether I agreed with their assessments. And I became even more hooked as these fellow analysts also began purchasing Allied Irish Banks for their personal portfolios.

As a result, I also began to give in to confirmation bias -- where I sought out opinions that further confirmed my buy decision, rather than seeking a contrarian opinion that might indicate danger ahead.

Seth Jayson, co-advisor of our Motley Fool Hidden Gems newsletter service, recently shared with me that confirmation bias is one of the most common predispositions investors face. He explained that truly great investors develop an ability to honestly look at both sides of an investment thesis.

Anchoring in loose sand
As if those errors weren't enough, I also became anchored to the price at which each service recommended the stock. I fixated on those price points; in my mind, anything lower than their entry prices became a clear bargain.

So, when Allied Irish Banks fell another 50% from the most recently recommended price, the stock became twice as attractive to me, as did the doubled dividend.

These mistakes fed off each other, collectively convincing me to overlook my normal investment process. I took shortcuts. I failed to perform as much research as I typically do. I fell in love with the stock, viewing it as mostly upside, without truly understanding the risks and pressure points. And I didn't even consider the possibility of a suspended dividend (which later came true).

The company -- which, hurt by the falling Irish economy, needed to boost its construction and development loan reserves -- was much more complicated than I originally thought. Andy Cross, also co-advisor at Hidden Gems, recommended to me that investments should always pass what he calls "Einstein's razor," which dictates that an investment thesis "should be made as simple as possible, but no simpler." The complexity of Allied Irish Banks forced me to look to other investors, bypassing my own investment process.

© 2009 UCLICK, L.L.C