Organization & Planning

Organization

The capital markets and the economy are complex, adaptive systems. They have millions of interacting agents (investors, consumers, businesses, etc.). They have thousands of inputs and outputs. And each of these variables have constantly shifting reactions to each other. 

For example, one day a strong jobs report can send stocks racing higher as optimism about the future takes hold. Then on another day, a jobs report that is just as strong can send stocks down, as investors worry about inflation, rising interest rates, and a less accommodative Fed. 

Without a way to organize this mountain of information into a manageable set of indicators, an investor is adrift on a sea of streaming data and talking heads. A skilled investor will organize this information in a way that prioritizes the things that are most important to them, and screen out the rest of the noise. 

How you choose to organize your investment process is up to you, but the best way I know of doing it is by creating an Investment Policy Statement (IPS hereafter). 

Investment Policy

I can only think of one type of investor who doesn't need an IPS. That's the investor who has a one-asset portfolio, and they strictly adhere to the buy & hold doctrine. When new money comes in, they immediately buy more of the asset. And they only sell if they need money and don't have enough ready cash on hand. This is as simple as it gets, and there is no need for a formal IPS.

Do you know anyone who has a one-asset portfolio and adheres to a strict buy & hold discipline? I've never met one, and I've been coaching and advising clients for more than 35 years. My point is that everyone needs an IPS, even if it's a simple one-pager.  

Writing an effective and useful IPS takes skill

I have helped hundreds of investors write their IPS. While there is no standardized form, there are certain key elements that should be included in order to make it a practical, living document. Practical in the sense that you will actually refer to it when faced with a particularly tough investment decision. Living in the sense that you will be frequently updating and improving it as you gain more skill and experience.

Investment philosophy

Nothing is more important to long-term investment success than a clear investment philosophy. More important than a sound investment strategy? Yes, because strategy, while important, is nothing more than a manifestation of your investment philosophy. strategies evolve as circumstances change, but your investment philosophy is based on the intractable belief you have in the principles that guide your decision-making. Your investment philosophy enables you to control your emotions, shut out the noise and focus on the things that really matter over the long term.

Examples of investment philosophies

Warren Buffet: Buy wonderful businesses at a fair price with the intention of holding them forever.

John Bogle: Buy-and-hold, long-term, all market-index strategies, implemented at rock bottom cost, are the surest of all routes to the accumulation of wealth.

Others: Diversify widely, rebalance regularly, minimize costs.

Anything is possible, and the unexpected is inevitable. Proceed accordingly.

Risk means more things can happen than will happen.

Investment strategy

Strategy is best approached from the top down. Start by deciding which asset classes you will invest in, to the exclusion of all others. (There are about 20 asset classes from which to choose.)

Next, assign a percentage weight to each of your approved asset classes. 

For stocks, start with the 11 major sectors and decide how much to allocate to each one. 

For each sector, decide whether to  use a broad-based sector fund or ETF, or hand-pick the industries that you think will outperform over your preferred time frame. 

If you decide to invest in individual stocks, use the same top-down approach.

Tactical plan

Once you have all of your ducks in a row, it's time to write your trading rules, risk management checklists, and rebalancing process. Part of this section is your contingency plan, where you lay out as clearly as possible, exactly which steps you will take and when you will take them, when the market is heading into a severe bear market. Be sure to include the steps you will take to reverse course as the market begins to move higher again.

Your IPS is a living document

It's unfortunate, but the majority of investors who go through the often painstaking process of crafting a great IPS end up sticking it in a drawer and never looking at itt again. Don't make that mistake.

Remember that you wrote it at a time when you were totally focused on what is really important to you. Once you put it in the drawer, your emotions begin to erode some of your rules, and you could end up violating some of your core principles. That's why I recommend that you review and update your IPS regularly - maybe once a year or so. You will almost always find things that need changing, and other things that you forgot about and as a result, led you to make a poor decision. 

Keep it fresh, and stay in touch with what Daniel Kahneman calls your "system 2" brain - the one that is thoughtful, reflective, and thorough. Pulling your IPS out of the drawer can calm you down when things in the market get a little crazy, as they always do.