How to learn from investing setbacks

Investing is very similar to building something with the aim of designing something flawless, the portfolio equivalent of the Taj Mahal.

If you look at the portfolio of public holdings at Berkshire Hathaway (BRK/A), you can discover what I am talking about.

In my opinion, the company has assembled a group of wonderful companies and businesses, with one holding more impressive than the next.

Hard Lesson

These businesses in my view are well-situated in large industries and are investing for the future.

Yet here’s the lesson I’ve learned after many years of investing: Some holdings an investor believes are  awesome don’t always perform as expected. Others will let you down.

Negative Surprises

Disappointment is part of life, and it is certainly part of investing, and how one reacts to these challenges can determine performance over the next ten years.

I bring this subject up because this week was one of those challenging periods for investors and several of my holdings took on the chin.

The one that got pounded has a great business, excellent leadership, scale, and a history of generating wealth for its owners, in many different ways.

Asset Allocation

In terms of my portfolio performance, the disappointing aspect of this is related to capital allocation.

If you own 10 or 15 different positions, and each one has a 7% to 10% weighting, your portfolio performance won’t be weighed down too much by any one holding’s performance.

If, however, one or two positions represent 25% to 30% of your portfolio’s asset value, your performance is going to swayed significantly by those holdings.

Now, if one holding explodes in value and has great prospects, having a lot of money tied up with that company isn’t necessarily a bad thing.

Sizing Up

The flip side is when you have a big chunk of your asset allocation in a company that doesn’t deliver as expected.

You’re building this work of art with the hope that all holdings will be spectacular, but the reality is that very few will live up to that expectation in my opinion.

So, in my view, the smart investor needs to take a hard look at underperformers and consider whether they’re worth owning.

Did something change in the business model which makes it less attractive? The reason why this is important is because investing is a journey and involves a long time frame.

Takeaway

In my opinion, we need to learn for our investing setbacks, and use them to make better decisions in the future.

If we do, in my view, the disappointment today will have been well worth it.

Photo Credit: Mark Freeth via Flickr Creative Commons