I was listening to Morgan Housel’s new podcast recently (which I highly recommend by the way), and he said something along the lines of; once you define your investment philosophy, you won’t be distracted by any noise that doesn’t align with it.
It really resonated with me.
Success with investing is more about avoiding mistakes than anything else. Therefore, having a clear, well-defined (evidence-based) investment philosophy will help you avoid getting distracted by any unhelpful ‘noise’, and keep you on the on the straight and narrow.
However, if you don’t have a well-defined investment philosophy, the risk is that you’ll be easily influenced and make financial mistakes.
I thought it might be helpful if I shared my investment philosophy which I can solidify it into four principles.
Principal 1: Short term returns do not help you achieve long term goals
You must align your investment decision time horizons with your goal time horizons.
Most people have a long-term goal of enjoying a comfortable retirement. Retirement will last two to three decades, hopefully longer. Therefore, you must align your investment decision making with that time horizon. That is, ask yourself what the best investment is you can make today that will maximise your wealth in 10, 20, 30+ years from now.
Short term returns do not create long term value. Let me share an analogy. If you operated a business, your long-term goal might be to create a sustainable and profitable business. Of course, you could reduce the price of your product for the next few weeks (offer a discount) to generate more sales this quarter. But that comes at the cost of creating long term value because it cheapens your brand and trains your customers to never pay full price. However, creating brand value might not improve this quarter’s results, but if you do it consistently, you are well on your way to deriving long term value.
The challenge with becoming a successful investor is that good, long-term investments just take time. That means investors must have a strong tolerance for delayed gratification – forgoing some wealth today for a lot more wealth in the future. As Warren Buffett says, the market is very good at transferring wealth from impatient to the patient (paraphrasing). There are no shortcuts to generating long-term returns. You just need to be patient.
Principal 2: You can’t build wealth if you don’t contribute
It is very difficult to create anything out of thin air, including wealth. Most things require some contribution of time, energy, money or something else. Building wealth is no different.
Successful wealth accumulation requires a regular contribution of cash towards growth assets. That could come in the form of servicing investment property holding costs, regular share market investing, additional super contributions and so forth.
Put differently, if you spend all your income, it will be almost impossible for you to build wealth in the long run. That means you need to manage cash flow effectively so that you can regularly invest some of your surplus cash flow. I’ve explained how best to do that in this blog.
To successfully build wealth you must invest on a regular basis.
Principal 3: You can’t pick unicorns
The thing with popular and new trends is that they often feel compelling. By definition, a popular trend benefits from wide acceptance which means a large audience ‘believes’ in the trend. It is easy to get swept up in this momentum.
However, if an investment lacks sound fundamentals, it is very likely (guaranteed) that its long-term investment returns will reflect its lack of quality. You can’t expect great returns from average quality assets.
In short, fundamentals don’t change! For example, the value of a stock is the present value of its future cash flows (i.e., its profit and cash flow). When it comes to property, a perpetually higher level of demand than supply will result in price appreciation (capital growth). These fundamentals (and many others) don’t change.
A couple of years ago I wrote about US truck company, Rivian. At the time, the company was valued at $US110 billion (market cap). But it had no fundamentals, and in 2021 I described its valuation as “insane”, because it had no fundamentals. It hadn’t even manufactured one truck yet! Since then, unsurprisingly, the company has lost 90% of its value. It’s now worth $US12 billion, which I think is still too high. Investing in an asset that lacks fundamentals is very risky – there’s no need to take such high risk.
The thing is, it is true that if you only invest in assets that have perfectly sound fundamentals, you will probably miss some good opportunities. There will always be unicorns that will explode in value and eventually turn into fundamentally sound investments. But, according to this article, a business only has a 0.00006% chance of becoming a unicorn.
Investing in sure things (i.e., high-quality, fundamentally-sound, evidence-based assets), might be a bit boring, but it gives you the highest probability of achieving your goals, which isn’t boring at all.
Principal 4: Invest tomorrow’s income, today
A mortgage is a wonderful servant but a terrible master.
Borrowing safely to invest in high-quality assets is a very powerful investment strategy. There are three very important words in that sentence; safely and high-quality.
Borrowing safely means that you have minimised the risk that interest rates will force you to make compromises on your standard of living that you are unhappy to make. Building wealth is a marathon, not a sprint. It is important that you don’t put your financial situation at risk through over-borrowing. Slow and steady wins the race.
Borrowing to invest magnifies (positive and negative) investment returns. Therefore, its only worth taking the risk (borrowing increases your risk) if your assets generate above-average investment returns over the long run. Put different, only borrow to invest in sure things (as discussed and defined above).
What is your investment philosophy?
In short, my investment philosophy is (1) always make decade-plus decisions (2) invest a specific amount of cash monthly (3) only invest in high-quality, fundamentally-sound, evidence-based assets and (4) use borrowings wisely.
We are bombarded with lots of stimulus by the media, on social media, through conversations with friends and family members, and so forth. There’s always a lot of noise vying for your attention – much of it is negative because humans have a psychological and chemical bias for negative information.
But most of his stimulus is unhelpful and shouldn’t inform your decision making. That is why it’s very important for you to have a well-defined investment philosophy – to stop you from letting your emotions influence your important financial decisions.
