THE FISCAL BLUE PRINT
WITH COACH JEFF MONTGOMERY
Episode 7: Developing Your Investment Philosophy
Last week we discussed the 4 parts of the investors mind:
- Cognitive: What we know – facts, statistics, data.
- Perception: How we see things. Your way of understanding or interpreting information.
- Instincts: How we behave. How you are programmed as a human being to react.
- Emotion: How you feel.
And we gave you a formula for potential success in winning this war: The cognitive part (what we know) must override all the other parts. Much easier said than done!
On top of all that we have the financial media stoking the fear and fanning flames! And those emotions override what we know (cognitively) what we are supposed to do. Those emotions are too powerful for most folks to overcome without some help!
So what we need to do is FLIP THE SCRIPT. And how we do that is to develop a CORE INVESTMENT PHILOSOPHY. On today show were going to give you some steps that will really help with developing an overall investment philosophy.
Disclaimer: Please do not take advice from me on this show. As a licensed Fiduciary I am only allowed to give advice to clients. Unless you’re a client, I can’t give you advice because I don’t know you. Think of this as helpful hints and education only and please, before implementing any information or ideas you hear on this show always consult your legal adviser, your tax adviser, and your financial adviser.
(3:45) Practical Planning segment: Now some of you may be saying “Jeff what are talking about? What’s an investment philosophy? I put my money in an account and the mutual fund manager or broker invest it for me. What’s all this nonsense about philosophy?”
What is a philosophy? It’s something that you wholeheartedly believe in right down to the CORE. Many of us have Core Beliefs in a variety of areas of our lives. For example; it can be religious, how you raise your children, or a core political philosophy.
- The first part of choosing your investment philosophy is to develop a True Purpose for Money statement!
This is a statement of the most important value that you want to express through the way that you use money; it is the thing that is more important to you than money itself.
What fundamental value will drive both your investing decisions and your spending decisions going forward?
- The second part is to develop a Market Belief by identifying what you believe about how markets work.
- The third part is to develop an Investment Strategy which is a plan to create and maintain your investment portfolio.
When you combine these three principles—your True Purpose for Money, your Market Belief, and your Investment Strategy –you have outlined your Personal Investment Philosophy.
(7:00) Let’s look at each one of these principles in a little more detail.
Your true purpose for money articulates the underlying values and priorities you want to address and the commitments that you wish to fulfill through the use of your money.
Most people are comfortable talking about goals or specific achievements that they want to accomplish with their money. But underlying these goals is a deeper and more meaningful value that drives your goals. Money itself does not bring happiness or financial peace of mind. One need only to follow the lives of many recent lottery winners to evidence the truth of this. We all need a foundation, a CORE VALUE!
Let me give you an example of what a True Purpose for Money might sound like.
My personal True Purpose for Money is Security, Comfort, Freedom, Love, Faith!
(10:00) Check out this video for a full recording of our most recent coaching class: Discovering Your True Purpose For Money!
The second step in Choosing your Investment Philosophy involves examining your beliefs about the market.
Our beliefs, whether conscious or subconscious, are the root of action. Beliefs about the market and how it works are largely responsible for dictating decisions made regarding investments.
Formed for many reasons and based on numerous factors, beliefs may be changed instantaneously based on new information or a new understanding. For this reason, it is important to consciously examine your beliefs about the market. There are two diametrically opposite belief systems about how the market works, and the nature of markets:
- The first one is the efficient market (or “markets work”) belief system says that free markets are random and unpredictable and that they will quickly reflect new information and knowledge as it becomes available.
- The second belief is the “markets fail” belief system which states that markets are inefficient and react slowly enough to new information to allow some investors and market analysts with access to more current information to take advantage of mispricing.
Most investors don’t even know or realize that there’s a choice to be made about how the market works, and what they believe. While there are investors in both camps, without an understanding of the fundamental differences in these approaches it’s easy to be manipulated, particularly by popular media which encourages behavior consistent with the idea that markets fail. (prognosticators & gurus in the media) For you to make your own choice, let’s look at both sides of the story.
(14:00) First, let’s examine the efficient market belief. What does it mean? Well, the name efficient market refers to the underlying premise of the view that the market, left to its own devices is efficient. It’s based on supply and demand. “The free market is the best determinant of market prices” ~Adam Smith Wealth of Nations, 1776.
What this means is that all knowable and predictable information about future prices and movements is already factored into the current price. Therefore, only new and unknowable information and events change prices going forward.
In this context, the randomness of the market makes it impossible for any individual or entity to consistently predict market movements and capture additional returns that are unrelated to risk. In other words……..Markets that are overvalued, or underpriced, are not identifiable in advance.
(16:00) Now let’s look at the other side of the story, otherwise known as the market failure belief. What does it mean? The basis for this belief is that free markets fail to price goods and services accurately. Because there are flaws in the systems, it is possible for some individuals to identify in advance which prices are incorrect, meaning that overvalued or underpriced markets can be predicted. By systematically finding mispricing, either in stocks or market sectors, it is possible under this belief, to both increase returns and avoid losses in investments.
Is there any proof? Empirical evidence supporting an inefficient market is poor.
Statistical studies show that professional money managers who attempt to take advantage of mispricing in the market are generally only able to provide higher returns than the market index at a level with what would be expected to occur by blind random luck.
On the other hand, there is a lot of anecdotal evidence to support this view, usually in the form of magazine covers and radio shows, TV talk shows or Internet chat rooms touting the latest individuals who have “beat the market.” These anecdotes are alluring to basic human instincts we discussed previously!
Perhaps for the first time in your life, you know there is a choice to be made about how the market really works, and you have started to examine both belief systems.
Many investors live in a haze of confusion, never understanding that there is an important choice to be made here. They are trapped in the Investor’s Dilemma, trying to rationalize beliefs on both sides of the continuum. The result is often portfolio chaos and confusion.
It is crucial that you take a stand regarding your market belief. This is where the rubber meets the road for the investor.
In order to develop your own Personal Investment Philosophy, you will need to choose between the belief systems of market efficiency or market failure.
Do you believe, as Adam Smith did, that free markets set prices better than any individual or group of people can? Or, do you believe that markets fail, and that there is an individual or group of individuals who can predict the “right” prices?
What do you believe? What makes most sense to you? If you need help with this step I have recorded a webinar to help you make the choice: https://vimeo.com/274730392/224785fb10
(20:00) The third part needed to help you develop your Investment Philosophy is your Investment Strategy.
There are two clearly defined strategies for investing; one associated with each of the specific market beliefs.
- The first strategy we will discuss is Asset Class Investing which employs an investment methodology that is consistent with the belief that markets work.
- The second strategy is known as Active Management. This approach is aligned with the belief that markets fail.
There are three tenets for each of these investment strategies.
(21:00) Asset Class Investing: The Asset Class Investing strategy is built on the tenets of Market Returns, Asset Allocation, and Lifelong Investing.
Asset Class Investing refers to a buy and hold approach to asset management. If you think markets work efficiently, then buying and selling securities in an attempt to outperform the market is effectively viewed as a game of chance rather than skill. This approach involves applying scientific, academically proven strategies of Modern Portfolio Theory. The three tenets of Asset Class Investing are:
- Market Returns: Use structured or index-type funds to deliver market returns for the asset classes in the portfolio.
- Asset Allocation: Expose the portfolio to multiple types of investments including: equities and fixed income instruments, domestic and international markets, and growth and “value” investments, to provide maximum diversification and correlation effects. The goal is to maximize returns for a given level of risk.
- Lifelong Investing: A step beyond “long-term,” investing is seen as a lifelong process. Instead of attempting to get in and out of the market at the “right time,” staying in the market all of the time is a fundamental part of success in Asset Class Investing.
(24:30) Active Management: On the other hand, the Active Management strategy is based on Stock Selection, Track-Record Investing, and Market Timing.
Active Management means actively buying and selling securities with the assumption that securities bought are worth more than the price paid, while securities sold are worth less than the selling price.
According to Webster’s dictionary, “speculation” means buying and/or selling in the hope of taking advantage of an expected rise or fall in price. Given that active management is based on the belief that the manager expects market prices to rise or fall in line with his or her predictions, it can be viewed as a form of market speculation.
The three tenets of Active Management, which are commonly used and accepted by retail investors, are:
- Stock Selection: Pick stocks that will get high returns in the future and invest in them. This technique can be implemented in both individual stocks as well as within other investment vehicles, such as mutual funds.
- Track-Record Investing: Utilize an investment’s previous performance to determine whether or not to invest in it for the future.
- Market Timing: Any attempt to alter or change a portfolio based on a prediction about the future.
(27:30) Summary: The entire premise of this series is Mind over Money and how do we win the war going on for our money and more importantly how do we win the war going on for our Peace of mind!
To win this war, it’s critical to pick an investment strategy that aligns with your Market Belief.
When we have market beliefs that are inconsistent with our investment strategy, the result can be confusion, anxiety, and often despair. But when our investment strategy and our market belief lines up, then the result is internal confidence and Peace of Mind.
Many investors believe that free markets work, but find themselves stock picking and trying to utilize market timing or using a fund manager or broker that is doing those things. COMPLETELY INCONSISTENT WITH WHAT THEY BELIEVE TO BE TRUE.
Once this conflict is identified, they are able to bring their actions into alignment with their belief and get the upper hand in this battle.
Let’s put this all together in a nice little package:
- You have done the work to discover your True Purpose for Money,
- You chose your Market Belief, and
- identify your Investment Strategy that is consistent with that belief
Putting them all together, you have developed your Personal Investment Philosophy!
(29:30) Coachable Segment: How can you use your Investment Philosophy in support of ongoing decisions and actions related to your investment portfolio?
It’s important to note that I am not making any judgements here. While I am personally in the “markets work” camp i.e. I believe that markets are efficient and that it is impossible to predict markets/stock prices in advance.
Go through the exercise and make your own choice!
If you believe that markets are efficient, and you support the asset class investing strategy, you should:
- Eliminate active management techniques (stock selection, track record investing, and market timing)
- Work with a financial professional who believes markets work, offers asset class investing, provides education, discipline and coaching
- Ignore media hype
- Set lifelong financial goals that are aligned with your True Purpose for Money
- Focus on seeking to capture market returns
- Utilize asset class or structured funds; not necessarily index funds.
- Diversify prudently
- Identify your risk tolerance
If, however, you believe that markets fail and support active management, your actions will be different. You should:
- Pursue active investing techniques to seek to capture inefficiencies in the market
- Work with a financial professional who believes in and implements active management strategies
- Stay connected to all sources of financial information (the Internet, magazines, talk shows, news, etc.)
- Read every article about stocks and options you can find or find a financial professional to do it for you
Either way, don’t forget to watch these 2 videos mentioned previously!
Be sure to visit fiscalblueprint.com to access the most recent content available including all past shows. Remember it’s not about the money but about your life! Having a mindset and living a life of abundance rather than scarcity will change the direction of your life forever!! Enjoy the Journey!!!
“Opinions voiced in this recording are for general information only and not intended to offer specific advice or recommendations to any individual. All performance references are historical and no guarantee of future results. All indices are unmanaged and not available for direct investment.”