Around six months ago, in the early knockings of getting this new endeavour off the ground, I sat down and had a couple of goes at writing down what I thought that my investment philosophy was.
Unfortunately, this exercise didn’t prove as easy as I had expected it to be. I definitely had a really good idea of how I felt that it shouldn’t be done, what I didn’t want to be, but none of us can solely define ourselves by what we aren’t. At some point we have to decide what we are.
After a couple of weeks of thinking about it, I finally got to a place where I felt comfortable enough to get it all down on one page. What follows are the foundational principles of how I think proper investing is done, a sound basis for any long term approach to growing wealth.
You don’t need to agree with all of it. You don’t even need to agree with any of it! That’s what makes a market.
But if any of us are to have any success in this game, then we have to have some foundations to cling to. These are mine.
1. Optimists prosper.
Every day, billions of people around the world get out of bed and head off to work. They don’t do this for the craic, they do it because they want to better themselves and provide for their families.
All of us play different roles but we all contribute to the ever growing global economy in our own ways. The pie grows because we are all incentivised to grow it.
And when difficult times arrive, human beings shine. We are undefeated at solving problems and it is for this reason that our progress is only ever stalled. Never stopped.
The best way, in my view, of gaining financial exposure to this relentless forward progress is by investing into the global capital markets.
Source: Dimensional. Returns are shown for the MSCI World index, in GBP terms. Dividends reinvested.
The stock market is not this abstract construct. It is a tangible, living breathing thing made up of unbelievable companies that produce real earnings.
And the reason that global markets rise in value over time, is because the aggregate earnings generated by the companies that make up these global markets rise over time. The value that investors ascribe to those earnings will rise and fall, and sometimes fall by a lot, but over the long run those earnings are only ever going up.
If you can look back at the progress that we, as a species, have made over the past hundred years and be anything but optimistic about what life will be like twenty or thirty years from now then I don’t know what to say. It must be exhausting to feel that way.
2. We are all, by default, shit investors.
As good as we are at solving problems, we are all extremely susceptible to biases which, if left unrecognised, can have a seismic impact on our investment returns.
The output of the financial media is designed to appeal to the worst of these biases and so we face a constant onslaught aimed at throwing us off course. Given that they spend their days reading the financial media, professional investors face the same challenge ten fold.
We must be honest enough to recognise our biases and take steps to mitigate their worst effects. Because it is in our nature to mis-step, it is logical to me that the best investing strategies follow a pre-established set of rules. Ideally, rules defined using the weight of historical empirical evidence and academic research.
By codifying our rules of engagement at the outset, we not only give ourselves the best chance possible of avoiding a major financial mistake at a time of high emotion. We also maximise our chances of a great outcome.
3. Risk is a fact of life. It must be accepted and can never be eradicated.
Like so many things in life, investing is not a game of absolutes. There is no one perfect answer, and every course of action will naturally involve compromise.
In order to try and grow our wealth, to ensure that we do not run out of money in the future, it is very likely that we will have to invest a proportion of our money into global equities. While such assets have an extremely robust track record of generating returns well in excess of inflation, in the short term they are occasionally subject to large swings in value (price volatility). Such periods of difficulty are inevitable.
This kind of price volatility is the cost of entry to accessing the (historically outstanding) returns that global equities offer. By accepting short term uncertainty in terms of outcome, we give ourselves the best chance we can of our capital rising in excess of the rate of inflation. If we hold fast to the relative certainty of cash, then we must accept that we will surely become poorer over time in real terms.
Wealth isn’t the number of gold coins in your bank account, it’s how much you can buy with those coins - your purchasing power.
I know I sound like a broken record on this stuff, but important points bear repeating. We must accept these truths now when the sun is shining and the sky is blue, so when it feels like the world is ending we can recognise that large drawdowns in the value of equity markets are a feature and not a bug of investing. Surprise is the mother of disaster for the untrained investor.
4. Risk and return are like love and marriage. You can’t have one without the other.
Other than your behaviour as an investor, nothing has a larger bearing on your long term investment returns than your asset allocation.
The larger the percentage of your wealth that you allocate to higher volatility assets such as stocks and property, the higher your longer term returns will be. The higher the percentage of your wealth that you allocate to lower volatility assets like bonds and cash, the lower that your longer term returns will be. Return and risk are joined at the hip.
It is simply not possible to generate returns which exceed inflation over the long term without accepting some kind of short term risk to the value of our capital.
Anyone that says otherwise has either revealed themselves to be either ignorant or a charlatan. Try to avoid both.
5. Diversification is a must.
While we must accept risk in some form as a fact of life, in order to prevent against permanent losses we must take action to diversify our investments. Not only across asset classes, but across sectors and geographically as well.
The logical approach to take is the “everything strategy”. Instead of looking for the needle, we buy the haystack.
6. Markets work efficiently to price in information incredibly quickly.
Stock markets have shown a consistently remarkable ability to behave counter-intuitively. The day after JFK was shot, the Dow Jones opened up. The FTSE closed higher the day that the UK chose to leave the EU. These are just two, there are countless examples.
Even if one can, whether through judgement or more likely luck, determine in advance how an economic event may play out – it is at least equally difficult to determine what the market reaction might then be and impossible to try to take advantage of this ahead of other market participants.
It therefore follows that it is impossible to try and time investment into financial markets. “Buy and hold” is the worst investment approach (apart from all of the other ones!), and the best results are seen by the most patient investors.
If the path of human progress is up and to the right, then we should give ourselves the maximum exposure to this progress over time, and not jump in and out depending on what day of the week it is.
7. Simplicity is genius.
The simplest solution is often the most elegant, and tends to be relatively low cost to boot.
The vast majority of the good that we can do for ourselves, we can do by simply “controlling the controllables” - and keeping costs to a reasonable level is something that sits firmly within our control.
We can also look to reduce the amount of decisions that we have to make along our investment journey, and with it the potential for mistakes.
Research shows that investors who hold fewer funds within their portfolios experience better outcomes. If we can get everything that we need from a single, properly diversified investment fund why would we go any further?
All of the tools that we need for financial success are readily available. There isn’t a cheat code behind a red velvet rope, the answer is hiding in plain sight. There is no need to complicate what doesn’t need to be complicated, none of us get extra points for difficulty in this game.
If you have some thoughts, I’d love to hear them. Don’t be a stranger, drop me a comment using the button below.
Past performance is not indicative of future returns. None of the above is intended to constitute advice to any individual.
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