Developing Your Investment Philosophy

Investing is not easy. Even after many years of studying and experience in investing, many investment managers can still find themselves flummoxed by the markets. Yet, everyone should have a strategy for investing for their futures, so that they can increase their personal value (#MyPersonalValue) and get the benefit of time in (not timing) the market (see Why You Need To Start Investing Now).

In this blog, I will discuss a way that can assist you in developing your investment philosophy and approach. It’s worth remembering that developing your investment philosophy and approach is not a once off event but rather an ongoing learning and refining process as your knowledge grows, and as you learn from your successes and your mistakes and also as your financial circumstances change.

Everyone is different, our brains are wired differently, we have different risk profiles, and we have different abilities and skills. So, whilst you can and should learn from great investors, you should be prepared to have your own unique philosophy and approach to investing. There is no magic formula that will make you a great investor or even merely an above average investor. If there was, then we would all be following that formula, and then by definition, all be average.

So, how do you go about finding the philosophy and approach that will work for you?

LEARN. INVEST. REVIEW

The diagram below simplifies the process:

Learn – find out about investing, read books and articles, attend courses, speak to experts and other investors, find out more about specific funds or stocks that interest you, try and understand the risks that you may be faced with, etc.

Then Invest – make an appropriate investment decision based on what you have learnt, your risk profile, how much you can invest, how much you are willing to lose. This is the action step, i.e. when you make a decision based on what you have learnt. And by the way: don’t stop learning during this time.

After you have given your investment decision a sufficient time to perform, you can then Review your performance – check how your portfolio has performed and if your assumptions have proven correct. If you’ve selected to invest with a fund or specific manager, how has that decision panned out for you and most importantly what have you learnt from this and what more do you need to learn?

This is a continuous cycle of learning, making investment decisions, and reviewing your performance.

Over time, you will find an appropriate investment philosophy and approach that is suitable for you. Your investment philosophy will mature over time, possibly with you taking more or maybe even less risk, finding the asset classes or mix of asset classes that is suitable for you, possibly taking more decisions on your own or even leaving more decisions to professionals.

Investment Philosophies

So, a possible path that you could follow in your journey of developing your investment philosophy and approach could be as follows. I am going to assume that you are looking to develop your philosophy and approach for investing in the stock market, so that you can get the benefit of higher returns and building your wealth over the long-term.

Passive Strategy

You could begin with a Passive Strategy, i.e. you could simply buy the market (which is represented by the stock market index). You could choose to buy the lowest cost exchange traded funds for the markets that you wish to be invested in and sit back and watch how you outperform 75% of the professional investment managers who invest in the same universe. Surveys show that most fund managers (some statistics say more than 75% of them) consistently underperform the benchmark that they have set themselves to beat. A passive philosophy could simply involve you buying the index and not worrying about which specific shares to acquire or even which funds or fund managers to put your money with.

But even in this case you will be required to make certain decisions: which markets should you invest in; how much should you invest in local markets versus offshore markets; how much should you have in equities, bonds and in cash, etc.? The big advantage of this approach is that your costs are low and any saving in costs is in fact a positive return to you. Over an extended period, an annual saving of 1% or more can have quite a material positive impact on your portfolio. To illustrate, the table below shows you the Rand value of an investment of a R1,000 per month over 20 years. An annual saving of 1% in costs for a R1,000 investment per month, over 20 years, can leave you with 14-15% more in your investment at the end of the 20-year period.

So, this could be quite a good strategy. This is called a passive investment approach. It’s low cost and it beats most fund managers.

However, you still need to make a decision on which exchange traded funds (ETF) to purchase: should be the All Share Index, the Industrial Index, a Dividend Fund, which offshore markets, etc.

Professionally managed

If you are not comfortable with taking a Passive approach or you think that you require an active strategy (because you want to beat the market) but you cannot yet manage your own portfolio, you can go with a Professionally Managed philosophy.

This is where you can approach an investment adviser or portfolio manager. An investment adviser can assist you in allocating your portfolio to the various asset classes and funds. But even this requires you to do some homework on a reputable investment adviser. Not all investment advisers are the same and some may be motivated by advising you on products or funds that pay them the best commissions.

In the same way that a 1% per annum cost saving can result in approximately 14% more value at the end of a 20-year, R1,000-per-month investment; if you employ a skilled adviser or portfolio manager, and her advice provides you with an extra (net, after her fees) return of 1% more per annum; then your portfolio will be approximately 14% larger at the end.

You can work out from the table, the difference on your portfolio of 2%, 3%, 4%, additional returns or costs per annum on the impact of your portfolio. The differences become more significant. So, a good adviser and/or portfolio manager can certainly provide real value.

So, an alternative strategy to the Passive strategy we discussed above is to seek the assistance of a professional. This could take one of 2 forms:

1. A financial adviser who can assess your requirements and risk profile and recommend certain funds for you: either ETFs or specific funds like unit trusts (also known as collective investment schemes). In this case, you will give up some fees and you will also hope that the adviser that you have chosen will deliver the way that you expected them to.
2. Selecting one or more portfolio managers (or funds) to whom you entrust your investment decisions. You could also have a stockbroker or portfolio manager manage a customised fund for yourself.

In this case the strength of your decision will be based on how good you are at finding either the right investment adviser or the right funds/portfolio managers with whom to invest. Unfortunately, you will only know how good you are after the fact.

Manage Your Own Portfolio

In the third scenario, you could manage your own portfolio. In this case, your cost structure is very low, if you open an account with a low-cost stockbroker. Ofcourse, here you have to select your own stocks. To do this properly, you need to have a methodology for selecting these stocks.

There are so many different approaches and strategies for selecting stocks. This is a topic of many books and articles. Strategies can vary from trading i.e. holding stocks for short periods of time through to long-term investing.

It is not the objective of this blog to discuss the merits and demerits of the different strategies but it is safe to say that different strategies do work at certain times, but don’t work all of the time.

My own preferred philosophy is to select key investment themes and then to create a universe of stocks that I would like to invest in, if they meet certain valuation criteria.

In a future blog, maybe the next one. I will discuss this philosophy and approach in more detail.

Concluding Remarks

The above approaches to investing need not be mutually exclusive. There is nothing wrong in developing a strategy that has a combination of the above. You could give yourself a portion of your investments for you to invest directly in the stock market yourself. The rest could be managed by professionals. And as your confidence, risk profile, and knowledge grows, you can start managing more and more of your own funds.

By investing with a recognised professional, you can also follow their strategy and see if you can learn from it. Why have they selected certain shares? What is their top pick/s of share in their portfolio? How do they compare with other investment manager’s funds?

The way to develop your philosophy and approach is to continuously learn, apply your learning, and review your decisions. You will start developing solid principles that you are comfortable with in your journey to building your wealth. At times, these principles will be severely tested by abnormal market conditions. And even these experiences will allow you to grow your investment prowess and ultimately you will use this to grow your wealth.

LEARN. INVEST. REVIEW. A simple process to starting the development of your investment philosophy and approach.

Sabir