How to create an investment philosophy
An investment philosophy is a specific investing style. Successful investors create an investment philosophy to govern their decisions on investing.
An investor may concentrate his investment on:
- businesses with strong income opportunities, or
- look for undervalued stocks, or
- organisations that generate consumption-intensive stuff (growth markets).
‘Philosophy’ versus ‘strategy’
Do not confuse “investment philosophy” with “investment strategy”. When you put your investment philosophy into action, this is your investment strategy.
If a strategy no longer generates a profit, refer to your investment philosophy to find a new strategy.
Why it is important to define an investment philosophy
If you do not define your own investment philosophy, you’re likely to:
- switch strategies,
- constantly change your portfolios and
- eventually, pay more for expenses and taxes
Basically, this means you have no direction in your investments.
During good times, everyone earns money regardless of their investment philosophy. Your investment philosophy will only be truly tested when things don’t go as planned. For example during a recession or bearish market.
The market is full of buzz with loads of information coming from all corners. To cut through all this noise, successful investors acknowledge the importance of having an investment philosophy to keep them concentrated on the essentials, especially during tough market conditions.
Your investment philosophy is the pillar where you build upon your strategies.
Some examples of investment philosophy
1. Value investing
Making money by buying undervalued securities. Many successful investors, such as Warren Buffet and Peter Lynch, are proponents of value investing.
2. Growth investing
Concentrating on firms that demonstrate signs of above-average growth, even if the value of their stocks seems highly costly in the price to book ratio.
3. Socially responsible investing
Focused on investing in companies that uphold a set of moral/ethical principles like better fuel efficiency, no cruelty to animals, reasonable salaries, etc.
4. Fundamental investments
Look at growth, income, management teams and the capital structure of a company before deciding whether to buy its shares. In other words, concentrating on companies with promising profitability.
Steps to create your investment philosophy
So, how do you create or define your own investment philosophy?
By answering the following sample questions about your personal attributes, financial position and views of the market, you can begin to see what investment philosophy fits you.
1. Understand your own personal characteristics
- Are you a patient person?
Most investment schemes require patience, something many don’t have. If you are impatient, consider a philosophy of investing which will pay off quickly.
- Are you a high, medium or risk-averse person?
If you dislike taking risks, embracing a plan that involves a large amount of risk is not suitable for you in the long-run.
- How much time are you willing to spend on investing activities?
Different investment strategies require different amounts of time and resources. Some demand more attention. In general, short-term investing strategies are more time-intensive than long-term buying and selling, and retaining strategies.
- What’s your age?
As you get older, you will not take risks willingly, in particular with your pension money. Past experiences in investing would also limit your philosophy and choice.
- Are you an individual or group thinker?
Certain strategies for investment require you follow the herd and some the opposite. Which is more appropriate can depend on whether you’re comfortable with conventional thinking, or are a loner.
2. Understand your financial situation
Your investment philosophy preference is also influenced by your financial characteristics, such as your employment stability, funds available for investment, cash requirements, and tax status.
- What do you think of your employment status, now and future?
Your investment philosophy is strongly affected by your perceived earning capability.
If you believe you can earn a high income with plenty of balance to spare, you have far more degrees of liberty in choosing your investment philosophy.
If it is the opposite, your investment strategy needs to be adjusted to accommodate your cash requirements.
- How much funds do you have for investment?
As the financial resources at your disposal rise, your investment philosophy options expand.
- What are your requirements for cash?
Unforeseeable requirements for cash is a threat. This is due to personal crisis such as an illness not fully covered by insurance or unforeseen loss of revenue.
Nevertheless, you could still include the cash requirements probabilities into your investment philosophy.
The anticipated need for money reduces your investment time horizon and may eventually require you to embrace a short-term pay-off investment philosophy.
- What is your tax status?
Investors facing heavy income taxes should opt for investment plans that decrease or delay taxes into the future.
3. What are your views on the market?
Your opinions on how the market conducts itself and the results of your investment approaches will certainly change as time goes by. But for now, just base your decisions on what you know currently.
Though consistency in applying your investment philosophy is important to investing success, it would be insane to continue if evidence keeps surfacing proving the philosophy wrong.
Your investment philosophy
Your philosophy can be either just one single strategy that best suits you or a mix of strategies.
It’s also best to work with a financial advisor while answering these questions. Acting also as a coach, a good and trusted financial advisor will educate and advise you besides identifying which philosophy best fits your investing profile.
Conclusion
Picking the right philosophy is absolutely critical for successful investing. However, to make the decision to pick which philosophy, you must look within yourself first before considering external factors.
The best philosophy is one that fits your character and needs.
This article first appeared in https://mypf.my
Follow MyPF to simplify and grow your personal finances.
-FMT
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