An investment philosophy governs your strategy

Every investment strategy requires discipline and commitment. You have to swear off impulse purchases and hot stock tips from a guy on your fantasy football team. If that one hits home, it’s time to figure out your investment philosophy.

Almost every financial service provider has a website or a youtube channel or a newsletter telling you what to buy and how to invest. Every one of them has a strategy for you to follow. But what makes that strategy right for you? Lots of times these communications include a lot of warnings or bells and whistles – the more hype they throw, the less you should listen. Investment advice shouldn’t sound like a pitch for a used car.

But it’s so tempting, isn’t it? The chance to be on the inside of the next big deal? It’s easy to forget that anyone who watches the video or visits the website is an insider too. New investors in particular tend to worry they might be missing out. That’s how your original strategy goes off the rails.

We’re not saying you won’t pick up a good tip sometimes or make some money. The problem with these tips is that they encourage impulse buys, often of high-priced shares. What’s hot today can tank tomorrow. Investing is a long-term game – there is always going to be the next tip, the next “must-have” stock.  An investment philosophy is how you keep your investing strategy on track.

What is an Investment Philosophy?

An investment philosophy articulates the core beliefs and principles that govern your investment decisions. Those decisions drive your strategy. Your philosophy adds guardrails that encourage discipline when the market is volatile. They are written for an individual investor or a brokerage.

We’re not talking Aristotle. Investment philosophies reflect your approach to the market. You could call it your investing style. Social Responsible Investing (SRI) is a popular new investment philosophy. Investors align their decision-making to the personal or political causes they support.

Warren Buffet’s investment philosophy is value investing. Value investing means you look for assets you believe are underpriced, with the expectation the share price will rise. Buffet is one of the richest men in the world, affirming that his philosophy is paying off.

Hedge fund manager John Paulson supports a Contrarian investment philosophy. Basically, that means he bets against the market. Contrarian investors believe the market is typically wrong when lows and highs are extreme, so they sell during highs and buy during lows. Paulson made billions when the housing bubble imploded.

A philosophy establishes a protocol for investment decisions. It clarifies the types of opportunities you think have the most value. It is the foundation for your investment strategy.

What Makes Philosophy Different than Strategy?

Your philosophy defines the style of investing you follow. An investment strategy is how you manage your portfolio within the confines of that style. Strategy is more specific to the day-to-day. An investor’s age plays a part in determining their strategy. Risk tolerance is usually higher among younger investors, but more conservative as they get closer to retirement. Strategies will change but the philosophy defines the sandbox you play in.

Discipline is the last piece of the puzzle. Investors can rationalize buying any asset they want as part of their strategy. There are some constraints around risk, but otherwise, it’s an open field. But if we look at the SRI philosophy as an example, new assets might not include investments in fossil fuels, tobacco, or private prisons. An investment philosophy enforces discipline within the strategy.

risk assessement

Create an Investment Philosophy

Some financial gurus claim the need for an investment philosophy comes as the result of an epiphany. They suggest that a significant strategic blunder caused them to pull up out of the weeds. But you don’t have to wait to take a hit to craft your philosophy.

The point is to identify your investment style and build your strategy within it.

Step 1: Get Your house in Order

Before you invest in anything, you need to take a look at your finances. If you’re swimming in debt, addressing that needs to be your priority. If you want to invest, you need to have the money to do it. For now, take full advantage of your 401k and put the plastic away. A healthy financial lifestyle is achieved by means living below your means. Less spending, more saving. This is how you prepare to build wealth.

Step 2: Explore Your Options

Choosing the approach to investing that best reflects your style is your first decision. Educate yourself on the options. Choose the style that best reflects your financial goals, risk tolerance, and your proximity to retirement. Consistently successful investors may refine the parameters of investment philosophy over time but maintain it during market ups and downs.

1. Growth Investing

This investment philosophy is entrepreneurial. People who choose it are comfortable with risk. Growth investors look for opportunities in emerging technologies and services. This often leads them to smaller companies or startups in a growth industry.

The Price to Earnings (P/E) ratio on these investments often trade higher. This philosophy rest on the successful growth of these businesses, which in turn leads to higher revenues and higher stock prices. Growth investors gamble that paying more now will pay off later. They invest intending to sell, not hold.

2. Value Investing

As noted earlier, Warren Buffet follows this philosophy. Value investing is a simple concept. Identify stocks that you believe are underpriced and buy them, with the expectation the price will rise. As simple as it sounds, don’t expect to become Buffet overnight.

This philosophy is for educated investors who know a bargain when they see one. Value investors aren’t chasing low prices, they find companies that are undervalued. This requires a good amount of homework and an understanding of market variables. The risk level is low, depending on your capital, but it takes more than instinct to be a successful value investor.

3. Technical Analysis Investing

This philosophy is attractive to investors with an analytical bent. Technical analysis investors look to a stock’s trading history and price changes as an indicator of future performance. This guides their decision-making on buying and selling assets.

Technical analysis investors are data hounds. They evaluate price and volume based on historical patterns and signals. Those data and the analytic tools assess the external factors such as supply and demand, that may impact price and volume. Risk tolerance here is likely moderate, but for these investors, having data is comforting. The devil is in the details.

4. Contrarian Investing

There is something to be said for defiance of the status quo. Contrarian investors never follow the crowd. This style of investing requires a high-risk tolerance and is not for the faint of heart. These investors believe the market itself encourages groupthink which doesn’t accurately reflect the opportunities available. Whatever the market trend, they tend to do the opposite.

Historically, contrarian investing is at its most profitable during economic downturns. When stock prices tumble as a result, contrarians lean in and buy big. More than price is considered in those decisions. The goal of the buy is to sell the stocks when the market recovers. Contrarian investors thoroughly vet distressed stocks to make sure the company will survive the downturn.

5. Socially Responsible Investing (SRI)

This investment philosophy continues to grow in popularity, particularly among younger investors. The concept here is to align your investments with social, environmental, and political views. SRI investors choose companies that share and support their personal values.

SRI investors begin by being exclusionary. If they advocate for climate change, no fossil fuel stocks. If they are concerned about gun violence, no stocks from gun or ammunition manufacturers. On the flip side, they might invest in retailers who stop selling guns. SRI investors are inclined to invest in emerging technologies that support their causes – alternative energy sources for example. This philosophy requires a moderate risk profile but has been consistently performing well for investors.

(Read: Do Your Investments Line Up with Your Values?)

6. Fundamental Analysis Investing

This philosophy focuses on identifying companies with high earning potential. These investors use quantitative and qualitative data to analyze that potential. The data allows them to compare the company to its peers and the overall market. The risk level here is moderate, depending on your capital.

Fundamental analysis investors do a deep dive into financial statements to understand a company’s revenue, growth potential, and risk level. They evaluate debt, cost control, governance and leadership. This determines whether or not shares are properly valued in the market. Which drives their decision to buy, sell or hold.

Closing

Spend some time on this decision. Your investment style is personal – it should reflect your personality, priorities, and goals. If you are already investing, look at what’s currently in your portfolio. Have you subconsciously found the investment style that suits you best? If you think so, how well is it performing?

More and more brokerage houses and financial service providers are declaring their investment philosophy. It makes sense to see if your broker’s style aligns with your own. It doesn’t hurt to have a conversation about why they chose their philosophy while you’re trying to find your own.

Step 3: Educate yourself

All investors want to make money. It’s an indisputable fact. Your investment philosophy and ensuing strategy are optimized when you understand how the market works. It’s okay if you don’t understand how markets work in the beginning. But if you want to be successful, it’s not okay to stay that way.

Here’s what you need to do:

Your investment philosophy should include some personal factors as well. Consider your tax status, always accommodate your risk preference and time horizon.

Your Investment Philosophy

Taking time to understand your investment philosophy is well worth the effort. We recommend that you write down your goals and priorities in relation to your investment style. This document is the foundation of your investment style. When you document it, it reinforces your commitment.

The next step is to take a strategic approach. Strategy is more detailed, more specific to your portfolio and the assets it includes. You should monitor your strategy and tweak it as needed. Your portfolio should be diversified with rebalanced every quarter. All of that happens within your investment style. Tweaking your strategy is how you adjust to changes in the market.

Once you’ve chosen an investment philosophy, discipline becomes your most important attribute. Hold to your goals, stick to your style and align your strategy to meet them.

More and more brokerage houses and financial service providers are declaring their investment philosophy. It makes sense to see if your broker’s style aligns with your own. It doesn’t hurt to have a conversation about why they chose their philosophy while you’re trying to find your own.

Step 3: Educate yourself

All investors want to make money. It’s an indisputable fact. Your investment philosophy and ensuing strategy are optimized when you understand how the market works. It’s okay if you don’t understand how markets work in the beginning. But if you want to be successful, it’s not okay to stay that way.

Here’s what you need to do:

Your investment philosophy should include some personal factors as well. Consider your tax status, always accommodate your risk preference and time horizon.

Your Investment Philosophy

Taking time to understand your investment philosophy is well worth the effort. We recommend that you write down your goals and priorities in relation to your investment style. This document is the foundation of your investment style. When you document it, it reinforces your commitment.

The next step is to take a strategic approach. Strategy is more detailed, more specific to your portfolio and the assets it includes. You should monitor your strategy and tweak it as needed. Your portfolio should be diversified with rebalanced every quarter. All of that happens within your investment style. Tweaking your strategy is how you adjust to changes in the market.

Once you’ve chosen an investment philosophy, discipline becomes your most important attribute. Hold to your goals, stick to your style and align your strategy to meet them.

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