Investment Philosophy

The investment philosophy is the foundation of the investment process. But what is philosophy? It is a way of thinking about certain subjects and encompasses a set of core beliefs. For example, one investor may consider the capital markets to be fully efficient, in which security prices reflect all relevant and available information about the fundamental value of these securities. For such an investor, the selection of specific securities for inclusion in their portfolio to generate alpha (a measure of how well an investment performs against a benchmark) becomes an exercise in futility.

Simon Sinek, the author of the book Start With Why says “People don’t buy what you do; they buy why you do it. And what you do simply proves what you believe”. I consider the investment philosophy to be the Why in the investment process. Every investor, whether s/he is a Do-It-Yourself type or prefers to outsource to a professional investment manager, should have an investment philosophy. If you are going to hire an external manager, you need to find out what their investment philosophy is and see if it is aligned with your own. Failure to do this could have financial consequences as it may lead to a wrong choice of investment strategy and hence poor investment outcomes.

If it is to be effective, one’s investment philosophy should be documented and only updated to reflect new or updated information and facts about investing and markets. To illustrate this, before 3 BC, the earth was believed to be flat. Maps and navigation systems were built on this idea. Now we know that the earth is not flat. This means that these systems that were based on the belief that the earth was flat became unreliable if not obsolete. But we can agree that the need to change one’s philosophy is not an everyday occurrence.

What can and does change on a more regular basis is the investment strategy, which is the subject of our next post. Stay tuned.