Overcoming Deathtraps in Investment Financing: Insights from Andrew Stotz, A Financial Expert

Financial intelligence is a scarcely developed skill in most individuals which is often responsible for their likelihood of success or failure in their personal, social and professional lives. A fundamental aspect of this skill is the ability to recognise and utilize opportunities even amidst scarcity. Remember the three motive of wanting money according to Maynard Keynes which include; transactionary, precautionary and speculative? The speculative motive embodies the idea of investment financing, and it is mostly accepted as the basis of wealth building.

Invariably, investment financing is often thought or learned from the perspective of what desirable skills to possess. However, it has been observed that an equally rewarding or even more rewarding approach looks at the subject in terms of the undesirable things we often take for granted in our day to day lives.

Financial investment expert and writer, Andrew Stotz, in his personal account of his financial investment failures titled My Worst Investment Ever identifies the key markers of a prone-to-fail investment and how a potential investor can circumvent these errors. The short book started out from the sampled opinions of the author’s friends and acquaintances, detailing their worst investment experience. It occurred that each respondent had such a vivid story to tell. The author describes the inspiration of the book as follows:

“In the world of finance, we are always talking about our winnings, about the story of our returns. But we so rarely talk about failures. Thus, the book is about investment failures.”

Stotz dissects the key drivers of a successful investment in four broad levels. In each level are decision errors that often cause the investor to lose out in the investment.

The first thing to consider is to deal with the basics. This involves thoroughly understanding the business venture; both its outlook and internal realities including its operating models, management team, and culture. According to Stotz, to avoid failure at the early stages of business, one must endeavor to put the basics in place.

The following decision errors emanates from not being able to deal with the basics:

1. Buying into an illiquid investment that is hard to sell
   According to Stotz, investing in unlisted private companies poses a unique challenge because it is very difficult to exit when you are no longer satisfied with the management.
2. Buying into an illiquid investment where you lack influence over management
   Here, it is stated that owning a minority stake is highly risky because as a minority you have little or no influence over the way the business is running. For example when you are an employee, there are times when management offers you your own shares in the company. In this case, you are better off when you avoid it since you will have no control over the management of the company. Moreover, you will have deferred your compensation, and if things go wrong, there may not be a buyer for your shares. Hence, the investor suffers due to lack of control.
3. Putting faith in an unproven management team
   Here, Stotz contextualizes a common belief that the familiar devil is much better than the unfamiliar angel. According to Stotz, the changeover of the management is crucial to the survival of the venture. This was a case of new management taking over a family-run business. In such cases, investors expose themselves to the risk that the new management is unable to make the business successful. Hence, the lesson here is to stick to proven management if possible.
4. Investing in people you don’t know and not revising their past and references
   Though this is similar to the previous case, it is however different because it goes beyond simply trusting on management to other things that informs our biases and irrational decisions. For example, some individuals make investment decisions based on how gracefully a pitch appeals to them or based on the culture, class or race of the people they are investing with. One must endeavor to carry out a thorough research or do what is called due diligence about the person’s past decisions and relationships.

The second driver is keeping an open mind such that you can easily overcome hureustics. Businesses evolve along with major and minor changes in the mode and social relations of production. A combination of macroeconomic and microeconomic forces could disrupt the market and set in a new ordinance. Therefore, the rational investor must keep an open mind and be ready to forego their favourite endeavour when necessary. This is simply “knowing when you must kill your darling” according to Stotz.

The following decision errors develop from failing to get past one’s residual knowledge:

1. Being oblivious or deliberately disregarding major shift in an industry      One major risk of investing in an individual stock is the risk that something major changes in the industry in which the company is operating. These changes can start small at first and can seem to have little impact. But they can gather steam. For example, during the Covid19 lockdown, investment in real estate, particularly office space financing, and transportation went down due to remote working.
2. Relying too much on professionals Author noted that one of the lessons of his career is that financial professionals are driven by many different factors than the the investor’s concern which is simply the performance of their investment. Also, it is often the case that brokers are cheerleaders for stocks rather than thoughtful analysts. Therefore, one must never eliminate the conflict of interest in the financial world. You must seek financial advice from people who disclose their conflicts of interest.
3. Buying the dip without a second thought
   You definitely will be facing a high risk when deciding which course of action to take when the price of stock is falling. Referencing the prospect theory by economist and Nobel price winner, Daniel Kahneman and Amos Tversky, Stotz proposes that when for example you, as an investor,  buy a stock at 100 and it goes to 110, you feel great, but when it goes to 90 you feel about two times worse than you felt great when it went up by 10. This will cause you to make mistakes when prices are falling.
   Also due to overconfidence, when the share prices start to fall we think if we liked it at 100 we should like it even at 90. However, a better way to think of this is that while the analysis may be correct, the timing may be wrong. The author argues that if a stock falls by 20 percent to 25 percent in most market, you’d be better off selling it and hold cash.
4. Ignoring the reality that things change for companies. Sometimes we are blinded by love– we like companies and their management so much and we know them so well that we think they will always be successful and be a good investment. But things change for companies. One must understand that previous glories do not guarantee success in the future.