Developing An Investment Philosophy Part 2 1 comments
(P.S: Sorry for any disturbances the advertisements above may have caused you)
Why do we talk about investment philosophy, rather than investment strategy? The latter suggests the formulation of a plan to achieve one's goal (making money in this case); how does one optimise return through planning in an environment which is highly dynamic, investment choices are numerous and entry/exit is nearly instant, and specifications (ie. the price vs value equation) are constantly changing? I am of course comparing and contrasting investing to the engineering industry, where planning is practised widely because the project is often long-term in nature, non-negotiable and difficult to exit once entered into contract, and specifications are frozen at the start and often inflexible.
The term philosophy also suggests that there are many angles of looking at things without any absolute right answer, as discussed in my earlier blog (see Part 1 ). Based on our view and understanding of how the market operates as well as our personal preferences and characteristics, we may take different approaches to the process of buying/holding/selling. Consider the analogy of crossing a busy road: he who believes in his agility will brave the traffic and rush across (averaging down); he who is risk-averse waits for the traffic to clear (low-risk investing approach); he who follows the trend will follow fellow road-crossers, with varying levels of self-checks (trend investing, momentum trading). Depending on his belief in his jaywalking ability and his view of traffic characteristics (vehicle speed, driver response to jaywalkers --->different in various countries(!), his past experiences in crossing a busy road, the jaywalker will have different roadcrossing "philosophies". So it is with investment philosophy: there are many ways to skin a cat.
Nevertheless, I believe there is a critical component that has to be integral to any successful investment philosophy: consistency of logic. That, of course, straightaway rules out astrology-based investment philosophies, as well as rumour-based buy-and-sell approaches. There are certain irrefutable truths on which one can build his philosophical bedrock. One, that business fundamentals ultimately drive long-term share prices. Different rational investors can have different views on prices (chartists believe prices capture business fundamentals even those that are not publicly available; fundamentalists think there is no short-term correlation between the two), but it is a fact that profits, shareholder value-orientation and management integrity never go out of fashion. Two, that market psychology and sentiment can induce more volatility than annual earnings growth; in an up year average GDP can grow at X% but the stock market might grow by 2X %; the reverse happens in a down year. Investor optimism/pessimism/expectations drive market volatility. Three, that for every buy, there is a sell. If one keeps this in mind, he will think twice before every trade, and consider who might be on the other end of the trade, and whether his counterpart might have an information advantage on the company which tips the odds. Which brings us to the last point, that investment philosophy and approach should leverage on the strengths of the individual. That is common sense; that is just an extrapolation of life philosophy to investing. For example, the small investor has an advantage in speed/flexibility of entry/exit (see Advantages of being a small investor ); what and how should he buy/sell? That is up to you to consider and frame your investment ideas around.