Investing philosophy
a. Why you need one
If you do not have an investing philosophy,
. you will be easily swayed by every new strategy and theory that comes along
. you will switch from strategy to strategy and you will have to change your portfolio accordingly. This will entail high dealing costs (transaction costs) and you may have to pay more tax
. you may find yourself executing a strategy that is not appropriate for you, based on the criteria of your level of aversion to risk, your objectives and your personality. This can lead to an underperforming portfolio and sleepless nights.
Many different investing philosophies are possible. Warren Buffett's philosophy is different from Peter Lynch's and from Neil Woodford's and all three of them have different objectives and their objectives may be very different from yours, so what works for them may not work for you. It is important to make the investing philosophy fit the investor.
b. Development of an investment philosophy
The three steps in the development of a detailed investing philosophy are:
. understanding the fundamentals of risk and valuation
. developing a point of view about how markets work and how they might break down
. finding the philosophy that suits you best
c. My stance on the Efficient Market Hypothesis (EMH)
“Guys who know where the market is heading are no longer at the Board of Trade. They are either retired or broke. And I can't think of any that are retired.”
- Everett Klipp, corn futures trader at the Chicago Board of Trade (as quoted by Mark Spitznagel on p.10 of his book The Dao of Capital – Austrian Investing in a Distorted World).
The Efficient Market Hypothesis states that the price of an asset reflects all information about that asset. There are three versions of the hypothesis, known as weak, semi-strong and strong. These versions differ in their interpretation of the words "all information" in the statement of the hypothesis: "weak" means "all publicly-available information from the past", "semi-strong" means "all publicly-available information from the past and the present" and "strong" means "all information from the past and the present, both publicly-available and available from company insiders"
The hypothesis has its supporters and its detractors.
Nobel Price in Economic Sciences was awarded to Fama, Shiller and Hansen this year. They each had differing and even conflicting views and findings on this subject. But is the Efficient Market Hypothesis really so important?
In the past, I worked for many years for Digital Equipment Corporation (DEC), a multi-national computer manufacturer with a huge range of very complex products and services and hundred thousand employees and factories and sales offices all over the world. DEC was later taken over by Compaq and then HP. While working for DEC, I often had very little information about what colleagues ten metres away from me were doing, never mind information about what colleagues were doing in other sales subsidiaries or manufacturing plants. For that reason alone, I'm skeptical that the sum of “publicly-available information” and the “information available to company insiders” is the total information about a company. In fact, even the highest-level executives DEC didn't possess every detail of “the total information about the company”. How could they? Even if you could amass all that detail, how could any human being remember it all?
Because there's always a (big!) risk that I am arriving at incorrect conclusions by extrapolating from personal experience, I'll quote some different examples: the Enron scandal and the 2007-2008 financial crisis showed that the accounting procedures of a company or the details of a financial instrument can be so complicated and obscure that even experts cannot understand them.
Taking a much simpler case now: when a farmer goes to a market to buy some cattle, is he interested in whether the price of the animals reflects all the available information about them? Is it important to him? Does he sit in the cafe at the market and agonise about this with the other farmers?
Even if it was important to him, there are events which are totally outside his control and outside the control of the seller, events which have nothing to do with the "available information about the cattle", events which are completely devastating and unpredictable. Nassim Nicholas Taleb has called those sorts of events "black swans".
An example of such an event occurred in the farming world in 1986. Cattle became infected with "Mad Cow disease" and had to be put down. The EU then imposed a ban on British beef. As a result, the price of cattle dropped so low that it no longer made any economic sense to sell cattle at all.
The first part of my investing philosophy is that the EMH is not even that important to me, as it seems clear to me that the price of an asset can reflect many other things than just the information about the asset.
If you do not have an investing philosophy,
. you will be easily swayed by every new strategy and theory that comes along
. you will switch from strategy to strategy and you will have to change your portfolio accordingly. This will entail high dealing costs (transaction costs) and you may have to pay more tax
. you may find yourself executing a strategy that is not appropriate for you, based on the criteria of your level of aversion to risk, your objectives and your personality. This can lead to an underperforming portfolio and sleepless nights.
Many different investing philosophies are possible. Warren Buffett's philosophy is different from Peter Lynch's and from Neil Woodford's and all three of them have different objectives and their objectives may be very different from yours, so what works for them may not work for you. It is important to make the investing philosophy fit the investor.
b. Development of an investment philosophy
The three steps in the development of a detailed investing philosophy are:
. understanding the fundamentals of risk and valuation
. developing a point of view about how markets work and how they might break down
. finding the philosophy that suits you best
c. My stance on the Efficient Market Hypothesis (EMH)
“Guys who know where the market is heading are no longer at the Board of Trade. They are either retired or broke. And I can't think of any that are retired.”
- Everett Klipp, corn futures trader at the Chicago Board of Trade (as quoted by Mark Spitznagel on p.10 of his book The Dao of Capital – Austrian Investing in a Distorted World).
The Efficient Market Hypothesis states that the price of an asset reflects all information about that asset. There are three versions of the hypothesis, known as weak, semi-strong and strong. These versions differ in their interpretation of the words "all information" in the statement of the hypothesis: "weak" means "all publicly-available information from the past", "semi-strong" means "all publicly-available information from the past and the present" and "strong" means "all information from the past and the present, both publicly-available and available from company insiders"
The hypothesis has its supporters and its detractors.
Nobel Price in Economic Sciences was awarded to Fama, Shiller and Hansen this year. They each had differing and even conflicting views and findings on this subject. But is the Efficient Market Hypothesis really so important?
In the past, I worked for many years for Digital Equipment Corporation (DEC), a multi-national computer manufacturer with a huge range of very complex products and services and hundred thousand employees and factories and sales offices all over the world. DEC was later taken over by Compaq and then HP. While working for DEC, I often had very little information about what colleagues ten metres away from me were doing, never mind information about what colleagues were doing in other sales subsidiaries or manufacturing plants. For that reason alone, I'm skeptical that the sum of “publicly-available information” and the “information available to company insiders” is the total information about a company. In fact, even the highest-level executives DEC didn't possess every detail of “the total information about the company”. How could they? Even if you could amass all that detail, how could any human being remember it all?
Because there's always a (big!) risk that I am arriving at incorrect conclusions by extrapolating from personal experience, I'll quote some different examples: the Enron scandal and the 2007-2008 financial crisis showed that the accounting procedures of a company or the details of a financial instrument can be so complicated and obscure that even experts cannot understand them.
Taking a much simpler case now: when a farmer goes to a market to buy some cattle, is he interested in whether the price of the animals reflects all the available information about them? Is it important to him? Does he sit in the cafe at the market and agonise about this with the other farmers?
Even if it was important to him, there are events which are totally outside his control and outside the control of the seller, events which have nothing to do with the "available information about the cattle", events which are completely devastating and unpredictable. Nassim Nicholas Taleb has called those sorts of events "black swans".
An example of such an event occurred in the farming world in 1986. Cattle became infected with "Mad Cow disease" and had to be put down. The EU then imposed a ban on British beef. As a result, the price of cattle dropped so low that it no longer made any economic sense to sell cattle at all.
The first part of my investing philosophy is that the EMH is not even that important to me, as it seems clear to me that the price of an asset can reflect many other things than just the information about the asset.