Fade Your Friends

• Posted by DynamicHedge
• on January 11th, 2013

There seems to be some out there who equate the presumed mis-judgement of others with actual insight.  Or more specifically, because they disagreed with someone else at some point in the past, they’re willing to take a contra trade each and every time that person expresses an opinion.  Sure, some people offer a good tell but don’t be so quick to pat yourself on the back when you’re proved right.  You’re short changing yourself in the long run.

Back in the early 2000’s I was working in the film business.  I was in a low paying position but worked long hours and saved all of my money.  I started to buy investment properties with the lowest down payments available.  When I bought my first property all of my friends thought I was insane to borrow so much money, especially considering the places I was buying were in “crappy” areas that would never get better, never appreciate in value, and never attract good renters.  Several years later, I had a decent rental portfolio of detached homes and duplex units.

Needless to say, I was very young and willing to assume enormous risk.  When you’re new to the market you have this ridiculous idea that compounding growth is a smooth curve with very little emotional stress.  My ignorance was reinforced because I accumulated properties in a rising market.  Luckily, this is around the same time I began to study markets in a serious way.  I gravitated towards books about asset bubbles and market panics and quickly learned that my thinking was totally naive.

Early in 2007 one of my tenants approached me to buy the house he was renting.  He was a hard working guy who managed the IT department at a university, but had no idea about real estate or markets in general.  I told him in no uncertain terms that it wasn’t for sale.  But the fact that he was inquiring left a big impression on me.  It was the spark that started a chain of events.  I started seeing for the first time the madness of the market.  It occurred to me that everyone who thought I was an idiot for buying years earlier now thought I was incredibly smart.  I noticed that 50% of television programming was filled with shows dedicated to making money in real estate.  Robert Kiyosaki’s “Rich Dad Poor Dad” seminars were in every major market.  My real estate agent had even purchased a yacht (Side note: try to be the guy selling the shovels in a gold rush).

I started linking the  information together and form the opinion that the market was critically overheated.  This opinion created a fear that if I didn’t correct my situation I would lose everything.  I was highly levered to housing and if the real estate market took the economy down I would have a tough time finding renters.  Even a couple vacancies would cause me to default on my monthly mortgages and be ruined.  My intuition had led me to the decision to sell.  So I went back to my tenant and told him I might be interested.  Then I sold another and another until my real estate portfolio was completely flat.

After the bottom came out of housing and people asked me how I knew, I’d answer with a glib, “As soon as my tenants started making me offers on the place, I knew it was time to get out.”  Of course, that was bullshit, and something I said out of ego.  A renter could have punted the question my way just to see how much the place was worth.  The renter asking to buy the place was isolated and meaningless datapoint from a rational standpoint.  The only important thing is that it was the spark required to realize what was happening around me which triggered my intuition and fear for my financial future.  But what was the lesson I imparted to those I came into contact with?  Whenever your renters want to own a home you should take that as a sign to exit the market?  Completely absurd.  This was just an easy way of explaining a complicated decision in a social setting.

There is a big difference between genuine intuition and knee jerk reaction.  The difference is similar to that of legitimate fear and run-of-the-mill anxiety.  Anxiety is a selfish impulse that exists to protect you from looking stupid.  Fear is a real emotion that lets you know that you are in danger and need to adjust quickly before you come to harm.  The problem is, too many people make decisions based on anxiety and then freeze up when they feel real fear.  This is the basic premise of behavioral finance.  I had anxiety at every step of my real estate investing career.  Every time I signed a document or leased a suite to a new tenant I felt anxious, but only once did I feel like I was going to go completely broke.

In financial markets it’s much easier to make a wrong prediction than a right one.  Variables like time frame, trade size, and your definition of success mean that every decision can look like a terrible one, even if only for a short while.  When someone tweets positive information about the market and another person condemns or “fades” it with a remark like, “I’ll take the other side of that trade!”  The fader is taking the easy trade every time.

I try and make sure that I’m paying attention, but I feel that allowing myself to get distracted every time someone I disagree with states an opinion is counterproductive.  Not only is it distracting a waste of energy but it stunts the long-term development of real intuition.

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