The Yin and Yang of Investing: Conviction, Humility, and Finding Harmony

After hours upon hours of research, you finally pulled the trigger on your next great investment. Fast forward six months, and you're down twenty-five percent, and now your brilliant idea is looking like a total flop…ouch! I recently listened to an investor presentation on the impact of artificial intelligence on the semiconductor industry when the speaker said something that resonated with me. He professed," the most important trait of a good investor is being able to balance conviction and humility," that is, having confidence in your investment style but being able to admit when you are wrong and take appropriate, rational action once your investment thesis breaks down.

Investing is not a science; it's a bizarre hybrid of art, science, and psychology.

There are endless techniques and philosophies used to make investment decisions. There are value investors who seek investment opportunities where the price of the security is lower than the value, as determined by the investor's analysis.

Growth investors seek companies that are reinvesting capital to grow earnings at a rapid pace, thus increasing the company's future value.

Technical traders buy and sell based on historical price and volume trends. And there are countless combinations and blends.

No matter the method, you will have the occasional blunder that'll have you scratching your head for years to come. If you're a value investor, you rely heavily on financial statements prepared by the company itself. If figures are being inaccurately reported (purposefully or in error), the assumptions that led to your investment decision are rendered useless. If you're a technical trader, you assume investor behavior will follow a pattern, but when that trend is broken, your trade may well fall flat. If you're a growth investor and a competitor emerges with a better, cheaper product or service, the growth story is over, and the stock price will follow. These are all risks, and no matter which school of thought you subscribe to, you will be wrong.

We can all agree that being wrong is not fun. It's not fun admitting you're wrong, and it's not fun trying to right a wrong. But how you respond to being wrong will have a major impact on your investment results. There are generally three courses of action:

1: Sell the position (in whole or part)

Liquidating all or part of the position is typically reserved for when a thesis is upended. You invested for a reason, and now that reason ceases to exist, so why continue? This is easier said than done because liquidating a position (at a loss) is the ultimate acceptance of defeat. Despite the difficulty, if the investment thesis is invalid, it's best to move along to (hopefully) greener pastures. Sometimes a piece of humble pie is the best remedy.

2: Add to the position

Adding to a position that has been beaten up is a show of faith. You were wrong (on the timing at a minimum), but the reasoning for initiating the position remains intact. Thus you can buy the same investment, for the same reasons, at a cheaper price (averaging down your cost basis). Your conviction must be high when adding to a position that's severely down, but it's important to ensure the thesis is truly intact, not a result of your ignoring contrary evidence.

3: Do nothing at all

Doing nothing at all is typically my least favorite option; it feels like such a cop-out. However, there are times when for tax, portfolio maintenance, or cash management reasons, it's best to sit tight and let the investment run its course.

An investor who lacks conviction will likely miss many fruitful opportunities, as they will lack the follow-through to make and maintain successful investments. An investor with a deficit of humility will see returns damaged by failing to admit erroneous judgments, ignoring signals contrary to their hypothesis, and holding or adding to positions that no longer meet their original stated criteria. To make better decisions seek to balance conviction and humility.

Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from James Vermillion, and all rights are reserved.