Session 42 (of 42): The Grand Finale

0:00 Hi, welcome to this my final session in the investment philosophies class. So let's gather together what we have up till this point. I started this class by saying that there's no one best investment philosophy, but there's one that's right for you. And to find it, you need to know who you are as a person, what your financial characteristics are, and find that best fit. If you try and invest in philosophy, no matter how well it's worked for other people, that doesn't match you as a person, doesn't match your needs, I can almost guarantee you that it'll fail. For whatever reason, it's difficult to sustain a philosophy that doesn't match your needs. So, let's start looking at some of the things you might want to keep an inventory of to decide what philosophy works for you.

0:46 First, you have to ask yourself, are you patient or not? And you might want to ask the people closest to you because you might call yourself patient but you might get a very different impression to the people around you. The truth is some of us are born more impatient than others. You can't change that. If you adopt a strategy or philosophy that requires a long time horizon and you're an impatient person, how is that going to work out for you? Second, you want to check out your risk aversion. Are you risk averse? And I know you can take tests to see how riskaverse you are. But often the measure of risk aversion is how uncomfortable are you with what you've invested in. The more uncomfortable you are, the more you're signaling to yourself, this doesn't match my risk aversion. Third, are you an individual or a group thinker? again with no no labels attached to you. Some of us want to hang out with our peers and want their their approval and others amongst us are more more willing to take them on and do the opposite. And again, we're you know some of us are more born more interested in one other than the other and trying to pick a philosophy that makes you what you're not, it's not going to work. So if you are a group thinker, you like to go along with a pair, you want their approval, that being a contrarian is going to be really difficult for you to be. How much time do you have available to spend on investing? If you have a job as an engineer or a doctor and you spend 12 hours a day on your job, you can't pick an investment philosophy that requires you to spend six more hours a day picking stocks. And finally, your age does matter. Less than many wealth managers think, but it does. If you're 30 years old, you can invest in a in things that might go wrong but correct themselves over time, but you might not be able to do the same thing when you're 65 years old. So, as you age, your needs change, your time horizon changes, and that's got to be factored into your decision process. So, those are the personal characteristics and the signs of a misfit where you pick a philosophy that doesn't match your personality.

2:48 Here are my three tests. The first is what I call the sleep test. I know it's incredibly unsophisticated, but it works for me every time. If you lie awake at night wondering what's in your portfolio and how it's doing, you fail the sleep test. My measure of a sleep test is when you when you pick your portfolio and you go to bed, your portfolio shouldn't even be on the top 10 list of things you go through. You should be able to sleep through the night. If you pick a philosophy that or a portfol or or a portfolio that keeps you awake at night, I mean, what have you accomplished? You might have slightly higher returns, but you're going to have cardiac arrests and ulcers to deal deal with as a consequence. My second sign of a misfit is what I call the life changed days. If your investments are such that if one of them fails, you have to change the way you live. You got to move houses, pull your kids out of the the schools they're in, move locations. It's not worth it.

3:48 You want to make sure that nothing you do puts what the way you live to a test. And third, you want don't want to do things which where you constantly second guessess what you did. I have two things that I you know two two acronyms that I used Romo and FOMO. Romo's regret over missing out. FOMO is fear of missing out. It's amazing how much time investors spend in those two spaces. The less time you spend in those two spaces, the healthier investing will be. And one sign of an investment philosophy is how much time you're spending in those spaces. Now, in terms of financial characteristics, what are the things that matter? Your job security matters.

4:24 The amount of money you have to invest matters. How much cash you need matters. And your tax status matters. All of those things will change over time. So clearly your philosophy should also shift as those characteristics change. Many wealth managers as I noted when you walk in and ask for advice. The first thing they ask you is how old you are. And many of them base what your investing should be on entirely on your age. I think that's that's a shortcut that'll often lead you to bad choices.

4:53 It is one element of what you got to factor in, but it can't be everything. So let's look at how each of these factors plays out in your investment philosophy choice. Let's start with job security. Most people who invest have other jobs that they have. Doctors, as engineers, as lawyers, and those jobs come with different demands, but it's well established that during a recession, even people with secure jobs worry about their jobs and demand larger risk premiums. And if you're insecure about your job, you can't afford to take as much risk in your portfolio. I'm stating the obvious, but might as well state it. Now, what you invest in will also be determined by what your perception is of your future earnings capacity. If you believe that you have going to make a lot of money and you're going to continue to make a lot of money over the rest of your life, you will invest very differently from somebody who has a lower ceiling on how much they can make and much more variability over time in what they make. So, your job security matters. The type of job you have matters in terms of what investment philosophy you pick. Of course, your job might be managing other people's money.

5:59 In which case, we'll talk about what you should do. But if your job is affecting your investing, it is natural. It's the way it should be. Second, how much money do you have to invest? Now, to the extent that you're investing your own money, the the choices you have will start to expend depending on how much money you have to invest. If you have only $10,000 to invest, there are far fewer things you can do than if you have $10 million to invest. But when you think about how much money you have to invest, don't just restrict yourself to your savings because you might also have money in pension funds or IRA or insurance savings accounts that have to be factored in and they're invested in places that have to be brought into the process. And finally, you know, to the extent that you might be restricted on some of those choices, some pension funds might might restrict you three or four choices. Those might determine what you can do with the rest of your money.

6:51 So, if your pension fund forces you to invest in the S&P 500, then with the rest of your money, you get a lot more leeway to invest in small cap stocks or alternative investments to round out your overall portfolio. Third, when you look at the future, you have to think about demands for cash that will show up which are unanticipated. Like what? You could get sick and you might need to cover healthcare. your children might need to switch schools with a higher tuition. That's got to be factored in.

7:22 So when you have unpredictable demands for cash, it has to be factored ahead of the fact into your portfolio that you might have those demands. If you're a portfolio manager, this shows up in a different way. your clients can change their minds and want their money back. You're saying, "What's the big deal?" As a portfolio manager, then you got to set aside enough liquidity being enough liquid investments that you can meet their needs. So, you might not know exactly what those cash withdrawals will be or when they will happen, but the probability of it happening will affect your philosophy.

7:55 Finally, your tax status matters because you get to spend after tax returns. When you face high taxes, then that's got to be factored into what you invest in, the strategies you adopt. It might not affect your philosophy as much as it affects your strategies. What makes this complicated is you might face different tax issues with different parts of your portfolio. On your pension fund, for instance, you might not be taxed at all. You can afford to invest in high dividend paying stocks, but on your savings, you might be taxed on an on an annual basis. So you got to be more careful about what you invest in and what it does to your taxable income that year. So the kind of job you hold, how much money you have to invest, cash needs which are unpredictable, tax status, all play into what kind of philosophy you pick. And finally, what you believe about markets is going to drive the philosophy you pick. Now you you're saying, "How do I come up with market beliefs?" Some of it comes from anecdotal evidence. Let's face it, the stories you're told about markets will find their way into your beliefs. Now, in this in in this class, we've looked at the empirical data, not as if it's going to give you an absolute answer to any of this, but it goes beyond the anecdotal evidence to see if historically this particular strategy has delivered returns. Your views on markets will change over time, though.

9:14 Mine have over the last 40 years based on what? Based on what I observe in markets. Sometimes things that I thought were true 40 years ago are no longer the things I hold on to. But staying consistent in investing philosophy and your core beliefs is central to investing success in my view. So get a sense of how markets behave and your if your reaction is I don't know enough that's okay. Form your beliefs based on what you know today. Revisit those beliefs as you get to learn more and let experience drive what those beliefs will be a year from now, two years from now, 5 years from now.

9:54 In this table, I'm trying to capture all of the different philosophies we've covered in this book. And I've classified them based on two dimensions. One is where the markets are driven by momentum. I, you know, they've gone up, they continue to go up. go down. You continue to go down by reversal which is contrarian or opportunistic which is okay can cut in both ways but you can catch mistakes when you find them and based on time horizon short-term medium-term long-term and you can use your own definitions to to to be comfortable and you can see the philosophies range from stock picking to market timing to arbitrage to activist growth and active growth investing. You can pick a philosophy and not I'm not going to put any of these philosophies as I said as the best philosophy. Pick the one that works for you given all of the criteria we've talked about the right investment philosophy is the one that best fits you. Okay. So you can either go with that single philosophy but we've also opened the door that sometimes there might be two or three philosophies that can cohabit in the same person. You might be a a deep value investor as your core philosophy but also believe that in markets overreact to bad news and add information trading as a component. So you know those are complimentary philosophy they're driven by fundamentally the same beliefs about market about markets that markets know push out too much one in one case you're taking advantage of the long-term payoff from that the other short term. Now, my only advice is don't mix philosophies or strategies and make contradictory assumptions about market behavior over the same period because those will be in conflict with each other. So, when you combine strategies, make sure you're drawing on the same beliefs about markets and make sure that you in your mind know what your dominant strategy is. From the example I gave about about investing in deep value and trading on information, make a judgment as to what the lead philosophy is and what the complimentary philosophy is because that should govern where you spend your time.

12:08 So in closing, the best way to find an investment philosophy is look within. So rather than read books on successful investors, spend some time thinking about what makes you comfortable, what makes you uncomfortable, and find a philosophy that fits you. and your choice of philosophy will be affected by what you believe about markets, how old you are, you know, all of those things we talked about. That's part of the reason I am not an absolutist. I'm not going to go around judging people based on how they invest because it's none of my business.

12:42 You choose your philosophy based on what you believe. I would choose my philosophy based on what I believe and may maybe both way. I hope you found these sessions useful and I hope you find a way to learn investment philosophy that best fits you. Thank you very much for listening.