Some Thoughts About My Investment Philosophy
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Funny how when you plan to invest, God laughs!
Good investment plans start with a great investment philosophy.
Investment plans are a set of actions designed to maximize returns. An investor's values and risk tolerance help shape investment plans.
The goal of any investment plan is to maximize returns while minimizing risks.
Show me an investor with poor returns, and I'll show you someone with no investment plan.
They may think that "to make BIG money" is an investment plan.
News flash, it's not!
Good investment plans have effective strategies to reduce costs and boost positive outcomes.
Creating good investment plans doesn't happen randomly.
The best-designed investment plans are a function of an investor's philosophy.
An investment philosophy is a way of thinking about markets and how they work.
Think of an investment philosophy as a blueprint of thoughts to drive investment planning.
Investors should have a disciplined approach to investment planning. The structured planning should be a reflection of a flexible investment philosophy.
Let me share with you my investment philosophy:
1. Price Determines Returns
The price you pay for an asset will drive your future returns.
Paying a high price for an investment could result in lower future returns over time.
Look for assets whose prices are undervalued when compared with the market or industry average.
2. Asset Prices Are Volatile
Volatility refers to the amount of uncertainty related to the size of changes in an asset's value.
An asset's price can rise or fall dramatically over time.
Look for an asset's fair value when the asset's price has high volatility.
3. Asset Prices Cannot Be Predicted
The volatility of asset prices causes their future movements to be unpredictable.
Analysts always get forecasts wrong, from earnings estimates to economic outlooks.
Thus, don't try to predict where an asset's price will go from here - it's a fool's errand!
4. Asset Prices Reflect Investor Outlooks
Asset prices reflect investors' outlook on its near-term future. These outlooks, both good and bad, are based on all publicly available information.
This information can be a company's fundamentals, industries' business dynamics, and regulations.
Thus, examine forward-looking outlooks when valuing asset prices and ask yourself, is the outlook wrong, and if so, what's wrong with the general consensus?
5. Asset Prices Reflect Investor Psychology
Market action is also a reflection of investor psychology or sentiment.
Asset prices move up when investor sentiment improves. A rise in investor sentiment can be due to improved earnings outlooks and robust economic data.
When companies issue profit warnings and economic measurements weaken, investor sentiment falls. Asset prices move down when investor pessimism rises.
Thus, look to market measures of investor sentiment to determine if asset prices are either over- or undervalued.
6. Big Investors Move Asset Prices
As a corollary to rule # 2, institutional investors drive market activity for most asset prices.
Large investors are pension funds, hedge funds, and venture capital firms.
The buys and sells of large investors can tell you a lot about whether an asset is fairly valued.
7. Investors' Bias Distorts Asset Prices
As a corollary to rule # 5, bias can lead to faulty assumptions about asset prices.
A bias is a faulty belief that distorts one's ability to invest well by ignoring evidence and facts.
Two examples of investor bias are confirmation bias and hindsight bias.
Use a data-driven investment process that assigns a probability of outcomes to reduce investing bias.
8. Asset Prices Reflect Liquidity
Liquidity is the idea that an asset can quickly be sold at a fair price in a secondary market.
The more liquid an asset is, the more likely the asset's price reflects investor demand.
U.S. Treasury bonds are an example of an asset with good liquidity.
Assets with good liquidity can be essential in generating positive returns on an investment portfolio.
Thus, changes in an asset's price liquidity can provide clues about investor perceptions of the asset's value.
9. Focus On Asymmetric Returns
An asymmetric return is when an investment strategy offers more upside potential than its downside risks.
This idea means the investment provides higher possibilities for profit than for significant losses.
Thus, invest in assets whose prices offer significant asymmetric returns over time.
10. Investing is a zero-sum game
There is no second place in investing, only winners and losers.
Investors want to avoid taking continuous losses on their investments.
Thus, always cut your investment losses short. Let your winning investments run until something fundamentally changes the asset's value.
Sometimes, even the best investors with a sound investing philosophy have occasional losses.
Those losses are not catastrophic because of the soundness of their investment philosophy.
So, in summary, before you make your investment plan, think about your philosophy first.
Your portfolio's future returns will thank you for valuing investment truths that drive good planning.
Thanks for reading!