It’s impossible to know in advance how any investment will turn out. Only in hindsight will you know for sure. So it’s likely that you’ll always put too much or too little money into any one investment.
This is why position sizing — the amount held in one investment in relation to the total portfolio — is so difficult yet important. Especially when it comes to losing money. Having too much money in a single investment that turns out badly can cost you dearly.
Bill Miller relayed this lesson when he talked about one of his biggest losses. It involved Enron.
Enron was a Wall Street darling, throughout the 1990s, that had a magical ability to grow earnings at will. Its stock hit a peak of $90 per share in the summer of 2000. But the price dropped over the next year or so.
Throughout the decline, the CEO, Kenneth Lay, assured shareholders and employees that the company would rally, urging them to buy more Enron stock, while quietly selling his shares.
The magic turned out to be accounting fraud. Continue Reading…