The Essentials of an Investment Philosophy
What is an investment philosophy?
An investment philosophy is a systematic way of thinking about how markets work (and why they sometimes fail). It also explains your belief that specific errors occur repeatedly in investor behavior.
Please note: “Thinking cannot be outsourced” Every investor must first possess the ability to think independently. In short, “Investors need to think different” Otherwise, it is impossible to develop a unique investment philosophy, especially since “In the crowd, it’s impossible to think independently or keep sane“
Looking for Market Mispricing
Why does an investment philosophy assume that investors will make mistakes? Because most active investment strategies are designed to exploit errors made by some or all investors in stock pricing.
However, the “efficient market hypothesis“taught in business schools does not acknowledge the existence of errors in stock pricing. In the real world, investors’ profits primarily depend on stock pricing errors.
Profiting from the Behavior of the Crowd
Market pricing errors are actually rooted in the behavior of people at a deeper level. When the investment behavior of the majority fails, leading to the frenzy of crowd behavior, the market manifests itself as pricing errors. This is when a select few investors with clear minds have the opportunity to capitalize on this opportunity and profit—this is what Graham repeatedly emphasized: the purpose of the market.
Why do we need an investment philosophy?
Most people don’t have one
Most investors don’t have one. Even asset managers and professional investment advisors are like this. They often adopt strategies that have recently worked for other investors, but when those strategies fail, they abandon them and switch to a different one, repeating the cycle.
Mistaking Investment Strategy for Investment Philosophy
The vast majority of investors—including many who claim to have a profound investment philosophy—actually lack a core investment philosophy. Most mistake investment strategy for philosophy and mistake imitating others for true conviction, which, unsurprisingly, is reflected in their past performance.
Why do we need an investment philosophy?
You may wonder, “Why do I need an investment philosophy?” The answer is simple: Without a foundational investment philosophy, it’s easy to jump back and forth between strategies, following the sales pitch of a certain advocate or a seemingly successful recent example. Without consistent thinking and a self-reliant logic, it’s impossible to develop sound reasoning, and certainly no logical results.
The Consequences of Not Having an Investment Philosophy
Not having a fixed investment philosophy can have three negative consequences for your portfolio:
- If you lack a guiding principle or a set of core beliefs, you’ll easily fall prey to charlatans or investment gurus—people who claim to have found a magic strategy that can beat the market.
- When you switch back and forth between strategies, you’ll have to constantly adjust your portfolio, which can lead to high transaction costs and increased taxes.
- A strategy may work for one investor, but it’s often not suitable for another, based on their investment goals, risk tolerance, and personal characteristics.
The result isn’t just that your portfolio may underperform the market; it could also lead to stress so severe it causes stomach ulcers. Even worse: When you have a firm understanding of your core investment beliefs, you gain greater control over your investment destiny, eliminating only those strategies that don’t align with your market perspective and tailoring them to your needs. Furthermore, you’ll be better able to understand the true differences and similarities between various strategies from a holistic perspective.
Buffett’s View on This Topic
I mentioned this at the beginning of Chapter 3, “Determination to Change,” in “Investors Beautiful Heaven“, shopping links in US,HK,MY,JP,AU,NL,TW“:
Buffett stated clearly at the 2009 Berkshire Hathaway shareholders’ meeting: “In my opinion, business schools only need to teach two courses: one is how to evaluate a company, and the other is how to evaluate a company’s value from an investment perspective and how to view stock market fluctuations.”
Please reread the quote from Buffett above, and you will understand: This is Buffett’s perspective on the topic of “What is investment philosophy?”
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