When I first started dabbling in the financial markets years ago, it wasn’t a pleasant experience. I made money at first but eventually lost it all, and losing one’s hard-earned savings was a heart-wrenching experience. It made me doubt if I could ever become a successful investor (I know it sounds naive).
While I saw myself as an eager student of the financial markets, I wasn’t under any illusion that it would be a stroll in the park. I knew the going would be tough, but I severely underestimated the amount of psychological endurance required, and the mental discipline needed to become great at this game.
Since then, I took away valuable insights after spending a good amount of time reflecting upon the past, and researching ways to sort out my process and work on my mistakes. Here’s what I wish I knew before I started this venture:
(I) Having an Investment Philosophy
One of the first things I learnt was that every investor needs an investment philosophy.
An investor needs an investment philosophy to crystallise what he or she really believes about investing and the markets. While not commonly published or widely discussed, every successful investor out there has an investment philosophy.
NYU’s Aswath Damodaran defines a philosophy as a ‘coherent way of thinking about markets, how they work (and sometimes do not), and the types of mistakes that you believe consistently underlie investor behaviour.” Damodaran also mentioned that the ingredients of an investment philosophy includes one’s beliefs of human frailty, market efficiency and the developing of strategies and tactics.
Legendary investor Howard Marks also emphasized the need for one and he advices all investors to pen down their way of managing things, including a comprehensive and overarching view of the value-adding process and management philosophy.
An investment philosophy will be instrumental in helping you to develop an efficient investment strategy to compound capital over the long haul. It will also guide in refining it over time and in learning from mistakes (which are bound to occur).
(II) Be clear about the goal and choose an appropriate strategy
In the investment industry, professional money managers are forced to be clear because they operate under a mandate that is clearly communicated to shareholders and clients. An individual investor should take a page from them and be clear about his or her objective for being active in the markets.
Next, the chosen investment strategy has to be aligned with the overall goal.
For example, if your goal is to make an average annual gain of 25%, but the strategy chosen is to build a portfolio of high quality bonds, then it could be a misalignment as the expected return of high quality bonds may not be as high as what you would like to earn. Conversely, if your goal is to make an annual return of 5% but with low levels of volatility, a levered investment strategy may not be appropriate as the volatility that comes with it may scare the daylights out of you.
This may be an obvious point, but many individual investors do not practice it out. They either get impatient with their strategy or/and are tempted by all other kinds of strategies or investment products that they do not understand, often to their own detriment and regret.
In a sense, investing your own money is ultimately a solitary and personal activity. You have to have a clear sense of what you exactly want out of the markets, and then choose a strategy bearing in mind the available time and resources needed to execute it as well.
(III) Know and execute your edge continuously
Choosing an appropriate strategy also requires you to know what your edge(s) is(are). An investment strategy naturally flows out of your investment philosophy and objectives, but knowing your edge is the next step to differentiation and the key to long-term success.
Do you have an information advantage: do you know vital information that others don’t? Or is your edge in analytics and insights? Or perhaps you have a different time horizon than other investors, which could be an edge in itself when the vast majority do not have the patience or capability to capture the change and effects from trends that take a long time to materialise.
I realised that if I can’t explain my edge clearly, I do not have one. Without one, an investor with a lot of luck will always be doomed to break-even at best. Take the time and do the homework to realise, develop and refine your edge. Once you know yours clearly, execute it ruthlessly and continuously.
(IV) Know that a winning strategy isn’t as important as a winning psychology
Having a winning psychology is an underrated point. It’s something less talked about especially among beginners, as most of the focus is on strategy and particular tactics to make money. However, having a strong investor psychology is something that is frequently emphasised by the greatest investors that Wall Street has ever produced.
It’s close to useless to having a winning strategy that is robust and having an edge that can be continuously executed without having the appropriate psychology to carry it out. For example, having a systematic automated investment strategy that has a 80-20 percent win-loss rate that produces a positive expected value over a period of at least 8 months may be a good system overall. But if the investor executing the system cannot handle the periods of time where 20% of the losses are happening, he or she is likely to abandon the system altogether.
Thus, it is just as important to work on developing a mental fortitude and a keen sense of your own psychological disposition as well as the state of others in order to take your game to the next level.
In short, by crystallising an investment philosophy, you are aware of your subconscious beliefs. By being aware of your goals and your beliefs about the world, you can choose an appropriate strategy that is consistent through-and-through. By choosing an appropriate strategy, you can work out your edge and refine it over time.
The minute I realised the above, my approach to everything changed and I became more aware of myself and what I seek for in the financial markets. My investment performance improved tremendously and I become one with my strategy; stronger in my psychology and execution.
- Develop an investment philosophy
- Crystallise the investment objectives / goals
- Choose an appropriate investment strategy
- Execute your edge continuously
- Work on developing a strong investor psychology