Did you know that you can have a choice when it comes to choosing how your money is invested? Most people didn’t know there is such a choice as your “investment philosophy.” Philosophy is defined as: the theory of principles underlying thought, knowledge and conduct.
Have you been caught in the investor’s dilemma of fear of the future, performance losses, track-record investing, unmet expectations? Well, choosing your investment philosophy can be that missing piece that will help give you peace of mind.
There are (3) principles to choosing your investment philosophy: Finding your “true purpose for money,” choosing your “market belief” and choosing your “investment strategy.”
1.) Your true purpose for money articulates the underlying values and priorities you want to address and the commitments that you wish to fulfill through the use of our money. Most people are comfortable talking about goals or specific achievements that they want to accomplish with their money. But underlying these goals is a deeper and more meaningful value that drives the goals. Your true purpose for money can be described in one “value” word (love, abundance, passion…).
2.) The second step involves examining your beliefs about the market. Our beliefs, whether conscious or subconscious, are the root of action. Beliefs about the market and how it works are largely responsible for dictating decisions made regarding investments. There are basically two distinctly different views about the nature of the markets. They are: Markets work, or Markets fail. This is the most important step in defining your investment philosophy.
- Markets work – based on supply and demand, the markets, left to their own devices, are efficient. All knowable and predictable information is quickly reflected in the current prices. Therefore, only unknowable and unforeseeable information and events (which no one can predict) will change the price – i.e. the tsunami in Japan, hurricane Katrina, the BP oil spill, etc. The randomness of the market makes it impossible for some individual or entity to consistently predict market movements in advance. Simply put, anything representing predictability in the future is based on anecdotal evidence only.
- Markets fail – based on a belief that the markets fail to price goods and services accurately. Because of flaws in the system, it is possible for an individual or entity to predict undervalue and overpricing in the market before they occur. By finding mispricing in the market, they can increase returns and decrease risk in investments. This is attributable to predicting something in the future.
3.) The third step is determining your investment strategy. There are (2) clearly defined strategies for investing, one associated with each particular belief about how markets work.
- Asset class investing: referring to a buy and hold approach to investment management. This approach involves 50+ years of academic, scientific proven strategies of Modern Portfolio Theory. Three tenets using this approach are: Market returns: using structured index-type funds; Asset allocation: involves multiple types of investments including stocks/bonds, US/international, small/value. The goal is maximum diversification to increase returns for any level of risk; Lifelong investing: for any given number of years, the goal is staying in the market at all times, not buying and selling at the “right time.”
- Speculative investing: Also known as active management, attributable to buying and selling securities with the assumption that they are worth more than the price you bought, and worth less than the price you sold. Speculation in Webster’s dictionary is defined as buying and/or selling in the hope of taking advantage of an expected rise or fall in price. Three tenets using this approach are: Stock selection: picking individual stocks that assume will achieve high returns in the future, Track-record Investing: utilizing an investment or investment manager’s previous performance to determine investments about the future, Market Timing: any attempt to alter or change the portfolio, based on a prediction about the future, i.e. getting in and out of the market at the “right time.”
Now, here’s where the rubber meets the road: In order to achieve true peace of mind, it is crucial to align your Market Belief with your Investment Strategy.
- Markets Work/Asset Class Investing
If you believe that markets reflect all knowable and foreseeable information and current prices are quickly reflected with this information, then the best approach is to diversify, asset class invest/rebalance and invest for a lifetime. You can disregard any media hype regarding the next “hot” stock pick, as you will have all the money you need and give you confidence and peace of mind toward investing.
- Markets Fail/Speculative Investing
If you believe that inefficiencies exist in the marketplace, then you are compelled to follow speculative techniques to discover them. (three tenets mentioned above) This means you have to stay plugged into all new information from all media sources including TV, radio, internet, magazines, etc. to give you the information regarding undervaluation and mispricing in the market.
Principle 1 (your true purpose for money) +
Principle 2 (your market belief) +
Principle 3 (your investment strategy) =
Your Personal Investment Philosophy