“The important thing about an investment philosophy is that you have one.” - David Booth
Regardless of whether or not you are a fan of Capital One credit cards, you have to admit “What’s in your wallet?” is pretty catchy. Maybe that’s because it gets to the heart of the matter so quickly. At the heart of solid investing is a similar key question: “What’s your investment philosophy?” Let’s explore why that’s so important.
Step One: You Think, Therefore You Are
First, at the very least, you should have one. As recommended by Dimensional Fund Advisors chairman and co-CEO David Booth, having any sort of investment philosophy is a critical first step in grounding you, and directing your decision-making toward your desired ends.
You’d think that would be a given, but many investors would be sorely put to articulate an overarching plan behind their individual trades. In the absence of an “all-weather” philosophy to guide your way, you’ll struggle to make sense of the economic news you hear. You’ll react emotionally to short-term market fluctuations and the crises du jour proclaimed by the media. You’ll spend too much money on unnecessary trades or lack the confidence to act boldly when it’s in your best interests.
Step Two: Make It a Good One
Even better than having any old investment philosophy is to have a good one. It should fit well with your personal goals and risk tolerances. It also should be based on the wealth of academic evidence on how markets are expected to reward patient investors.
Read our evidence-based Investment Philosophy and see if it makes sense to you. Contrast it with questions I hear from those who have not yet crafted their best-laid investment philosophy: (1) Is the stock market being manipulated to benefit one political party? (2) If Governor Romney is elected president, will the stock market go up? (3) When will Facebook’s stock go back up to its issue price?
Our answers are, in order, probably not, maybe (maybe not), and who knows? These brilliantly non-committal answers reflect that they are the wrong questions to begin with.
If long-term market growth trends upward — and all evidence to date indicates that it does — why not focus on that instead? Wall Street often profits on flimflam, pretending that you need guru prognosticators to predict impending individual winners and losers, but the evidence indicates that you’re best off ignoring these theatrics and adopting a sound investment philosophy to carry you through.
We elaborate on this theme in our Key Insights quarterly newsletters
For example our April Key Insights newsletter recommended focusing on what you can actually control:
- Forget about trying to forecast near-term moves in the market.
- Form a sensible investment plan that aligns your personal goals with the market’s long-term risks and expected rewards.
- Implement a well-structured portfolio to reflect your plan.
- Stick with it.
If you’ve ever read the book or seen the movie Moneyball, you know that one of the practices of Oakland Athletics’ general manager Billy Beane is to avoid watching his team’s baseball games live. Why would a manager do that? Because he knows he might succumb to irrational decisions based on the heat of the moment. Instead, he stays focused on his evidence-based philosophy on how the game is best played.
Similarly, you can fret about your investments play by play, or you can follow a sensible long-term approach based on the evidence of what will bring you the most “wins” for the least cost. The choice is yours.