Many of the world's leading investors will tell you that nothing is more critical to long-term investment success than a clear investment philosophy.
Investment philosophy is based on your intractable belief in the principles and practices that guide your decision-making. In times of market upheaval and through the dark of uncertainty, your investment philosophy enables you to control your emotions, shut out the noise and focus on the things that matter over the long-term. Your investment philosophy keeps you focused on the process, which is your investment strategy.
A defined philosophy is critical when advising private individuals. As behavioural economics has shown, people are much more risk-averse than they might own up to. When under stress, they make highly reactive decisions. In the investment markets, this can be very detrimental.
Clearly articulating the why of their investments will help your clients in precisely those moments.
An investment philosophy is usually derived from two mainstream approaches;
Risk Profiling or Strategic Asset Allocation (SAA): which typically believes that:
- Psychometric risk profiling is the most appropriate way to determine an investment strategy - i.e. an investor's appetite for gain or tolerance for loss
- Risk means the volatility of capital
- History is the best guide to future outcomes
- Modern Portfolio Theory can be used to build optimal portfolios based on historical data, as markets are always efficient and repeatable
- Investors are always adequately rewarded for risk, so a long-term Strategic (or Static) Asset Allocation works best
- Markets will always revert to their mean average, dragged by some force of financial gravity to return to historical rates and ratios, suggesting little value in managing asset allocation.
Goals Based Investing or Dynamic Asset Allocation (DAA) which typically believes that:
- Investors actual needs and goals are the essential starting point to determine an investment strategy
- Risk is defined as the probability of not meeting an investor's goals
- Investors will have numerous different goals - so no one strategy or profile will suit all needs
- Markets are not always efficient - risk-reward opportunities arise from time-to-time
- Forward-looking estimates and projections are more relevant than historical data - as markets will not always perform as they have historically
- The world is continuously changing - more flexible and broad-ranging Dynamic Asset Allocation tolerances can help derive value or protect from capital losses
- Protecting capital is of paramount importance.
Some examples of investment philosophies of well-known investors include:
- Warren Buffet: "Buy wonderful businesses at a fair price with the intention of holding them forever."
- John Bogle: Buy-and-hold, long-term, all-market-index strategies, implemented at rock-bottom cost, are the surest of all routes to the accumulation of wealth.
Other examples of brief but all-encompassing investment philosophy statements:
- Diversify widely, rebalance regularly, minimise costs, rinse, repeat.
- Anything is possible, and the unexpected is inevitable. Proceed accordingly.
- Risk means more things can happen than will happen.
It can be beneficial for a financial adviser to be able to articulate the elements of their investment philosophy. It helps your client understand and entrust you with utmost confidence. Whatever your philosophy or beliefs determines your strategy and how to implement it.
Contact us to discuss how Dynamic Asset can help to fulfil your investment philosophy.
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