Why an Investment Strategy
If you are a DIY stock-picker, then you’ll need to get a stock selection method in place. Because if there’s one certainty on the stock market, it’s the certainty of losing money by randomly picking individual shares on a whim or following the advice of a Twitter guru.
It’s very rare to find an investor that can consistently pick stock market winners solely through intuition or discretionary research. I believe that all of us as retail investors have gone down this route – I personally did – and, being honest, most of the time with pretty disappointing results. Alternatively, forming a set of sensible guidelines and having the discipline to stick to them should keep you involved in more suitable investments.
That’s precisely an Investment Strategy
Whatever investment strategy should be simple to follow, easy to summarise, and able to answer these two questions:
- How are you going to invest?
- Which will be your stock selection method
A smart investment framework to start with
A smart investment framework will be your safety net when the markets head south or when you screw up with some stock. With a smart strategy in place, you should not go broke even putting a monkey in charge of the stock selection.
Playing within a smart investment framework leads to better investment decisions. The information overload is curtailed, as the number of investment possibilities reduces significantly.
Knowing “how” you are going to invest is more important than “where”. You need to set your rules in each of the following points and stick to them.
- Asset Allocation: Define how many stocks you want to hold and allocate them.
- Frequency of assessment and rebalancing.
- Lump-Sum or periodic contributions: That’s key to define your target Asset Allocation.
- Diversification: Currency, Industry, Country & Size. And of course, how much cash you to keep.
- Selling Signal: Don’t get in without knowing where is the exit door.
- Stop-Loss: Don’t get in without knowing where is the emergency door. How much are you willing to lose? Be honest with yourself and set a strict stop-loss on your lower bound.
- Buying Signal: You have already made your selection, but, when is to correct moment to purchase it?
- Buying approach: Full position in or dollar cost average.
Stock selection method
The truth is that we as human beings have limited judgment. From behavioral economics, we know that when people are confronted with vast amounts of data, our brains create mental shortcuts to help us make decisions. These shortcuts – heuristics -, act as a sort of rule of thumb on which we rely when making complex decisions. The only way to overcome this limitation is the quantitative approach.
The investor does not need to follow his subjective judgment, the rule of thumb, his intuition. Rather only the empirical relationship of historical data and the desired outcome are used to draw conclusions. Based on hard financial data, there is almost an infinite number of investment strategies.
- Value investing: A well-known and with the best historical reputation is Value investing. Simply speaking, you buy stocks when they appear cheap — as measured by a few financial ratios such as P/E and yield — and then you sell them once they become more expensive.
- Dividend Growth Investing: It’s easy. It involves buying shares of companies that pay continuous quality dividends, then letting the shares sit there unless you want to buy more. Of course, you need to make sure the dividend growth is being financed by higher levels of real underlying profit, not debt.
- Fundamental approach: Fundamental investing involves analyzing the key financial ratios of a business to determine its financial health, in particular concerning its capabilities to generate income cash-flows and lower levels of debt.
- Momentum investing: A Momentum investor aims to purchase stocks that have been showing an upward price trend. The main rationale behind momentum investing is that once a trend is well-established, it likely to continue. Unlike fundamental or value investors, momentum investors are not concerned with a company’s operational performance.
But you don’t need to stick to one and put aside all the rest. Sometimes, a good combination of two to three can suit you best. As far as it is based on sound investing principles, it has been tested on empirical data and you feel comfortable with it, it’s a valid stock selection method.
Transparent and independent thinking
The Sleepy Investor has been in your role and recognizes that, for the novice investor, the stock market can be a bewildering place. There are thousands of companies out there, all spread over various industries and countries. And with every company issuing a never-ending stream of corporate news and mystifying accounts too, there’s a real danger of “information overload”.
However, there is good news. The Sleepy Investor has done all the work for himself already and is happy to share and inspire others. In the RQM strategy, all those points are sorted out and become an unrivaled handbook for all those who have traveled this route before.