In my previous article, I focused on volatility and why you shouldn’t fear it. In this article I would like to take a step back and focus on the importance of having an investment philosophy.
What I mean by this is creating a set of beliefs and principles that provide a guide or reference point for you when making investment decisions. Having a set of core beliefs about your approach to investing can go a long way towards keeping you disciplined during difficult market conditions and help block out the noise generated by some of the media.
Why is it important to have an investment philosophy?
An investment philosophy is a map to your approach to investing and the decisions you make. Imagine you are going for a hike in a place you’re unfamiliar with. You can try to use points in the distance or landmarks as a guide, but this could easily get you lost or heading in the wrong direction should the weather change and visibility become difficult. What you need is a map. Your investment philosophy is that map that you turn to when making investment decisions, just like when you refer to a map during a hike to make sure you are heading in the right direction.
How to choose an investment philosophy
The world of investing has multiple schools of thought including : Value investing, fundamental based investing, growth investing, socially-responsible (ESG) investing, technical investing and smart beta just to name a few. Whilst each have their merits, how they apply to you and your views on investing is also of great importance.
Here are a few factors to consider:
How do you think about risk? Risk and return are related and in general the higher your target return, the more risk you will have to take. However, risk appetite and risk capacity (capacity for loss) are not the same thing. You need to ensure that you have the capacity to recover should you suffer a significant drawdown.
Do you like speculating? Some investors try to beat the market with predictions and weigh investments towards regions or assets that they expect to do well, while others believe in a structured and disciplined approach that favours consistent gains over occasional quick wins.
Diversification vs concentrated bets: There are investors who favour particular asset classes, countries or sectors. However, spreading your investment across thousands of markets, credit ratings, maturity structures and geographic regions can mean less risk and better coverage, so you’re in a position to take advantage of more upswings and be affected by fewer drawdowns.
What is knowable and what is not?
Most of the investment industry sells its ability to predict the future. This is despite the fact that finance academia continue to compile mountains of evidence that these efforts at prediction fail to add value to investors. Therefore, knowing that we cannot predict the future, even though some claim to do so, what can we do? Our view is we can add value to an investment philosophy by utilising the academic research and financial theories that are tried and tested and available to us. This approach is described as evidence-based investing. This can be a great help to an investor’s decision-making process and allows them to back up their process with evidence rather than a feeling or belief.
With this approach, investors can make decisions about their investment portfolios based on what they know is factually true. Instead of following market trends, investors can use research and historical data to guide this within their decision-making process.
As a financial planners, our role is to talk our clients through these choices and their decision-making process. There is no one right answer when it comes to investing, however using expertise and experience along with academic research and historical data can certainly add value to an investors overall decision-making process.
Remember, finding your destination is normally easiest when using a map. Why would you not use this same rational to your investments!
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