General
Mistakes Can Teach Valuable Lessons
The best thing about mistakes is that you can learn from them. If someone else made the mistake, perhaps you can learn without suffering painful consequences.
The U.S. economy made two big mistakes in a period of less than ten years.
First, in the late 1990's money from venture capitalists, fund managers, and individual investors bid the stocks of Internet-related companies to absurd levels. When lack of revenues and profits caused those stocks to crash, shareholders and employees suffered greatly.
The second big mistake was the assumption that high appreciation rates for houses and condos would continue forever. In fact, prices of most residential property investments have declined in the past year or two. Mortgages were financed by investors who made the same mistake on housing prices and now find that securities based on riskier mortgages have lost value as the assets backing them have been foreclosed and sold at greatly reduced prices.
Both of these boom and bust cycles have hurt all U.S. residents to some extent, even those who did not make large investments in dot-com stocks or houses and condos. Diversified portfolios declined somewhat as the bubbles burst, but diversification has allowed investors to preserve most of their capital. That is an important lesson to learn or have reinforced.
Another lesson is that following a herd can be dangerous to your wealth. When many people seem to be getting great results with a particular investment strategy, it is usually too late to invest in that strategy. The entry price has risen too far, and you may realize that you should exit the strategy only after the price has dropped sharply, so your return will be low or negative.
It's very hard to follow a different approach than the herd is pursuing, because our brains are wired to be conformists. When our species was evolving, living within a group and using proven methods for finding food and shelter increased the chances of raising children to maturity. Over many generations those early humans came to conform more and more to the approaches used by others, because those who lived alone or tried to find food or shelter in a new way often did not survive. While the modern world presents very different challenges that may be met best through innovation, our brains tend to work similarly to the brains of our primitive ancestors.
The second lesson from the big mistakes of the last ten years is thus not to get caught up in investment manias. What you should do is use approaches like dollar-cost averaging and rebalancing that tend to make you buy more of the out-of-favor investments and less of the "hot" stuff. Such approaches increase the likelihood that you will invest at a low entry price.