An email from a reader got me thinking about my investment philosophy.<\/p>\n
\u201cOften, financial authors, advisors, and experts refer to investment philosophy. What do they mean by this, and what are the principles of forming one?\u201d<\/p>\n
I responded, but it was such a good question\u2014and frankly, such a thought-provoking exercise for me to articulate my own investment philosophy\u2014that I wanted to share my response more broadly.<\/p>\n
Investment Philosophy Versus Investment Strategy<\/p>\n
An investment philosophy is a set of core beliefs that you\u2019ll use to guide your plan and your decisions; it underpins your strategy. An investment strategy, meanwhile, is where the rubber meets the road; it\u2019s the approach you\u2019ll take to executing your philosophy. Perhaps you\u2019ll maintain a focus on smaller-cap and value stocks, for example, or keep things ultrasimple with broad-market index funds. You could take it a step further and articulate a process that you\u2019ll use, like the screens you would run to identify worthy smaller-cap value companies, or how often you\u2019d rebalance your asset-class exposures if you\u2019re using broad-market index funds.<\/p>\n
The reason it\u2019s important to start with a philosophy is that it can help keep you on track and tune out distractions. For example, while SpaceX SPCX<\/a> captured headlines over the past few weeks with its initial public offering, an investor operating with the philosophy that active security selection is futile could simply pay attention to whether the company was likely to be included in major indexes. (The passive investor wouldn\u2019t even have to do that, really.)<\/p>\n Make Your Investment Philosophy Personal<\/p>\n As with investment strategy, your investment philosophy should be pretty straightforward. In fact, if you have more than five or so core principles, you\u2019re probably making it more complicated than it needs to be. Think big picture. What views do you have about investments that are unwavering and are so ingrained that they\u2019re practically an extension of your personality? If your principles fit that description, it means you\u2019re much more likely to stick with the philosophy through thick and thin.<\/p>\n As I thought through my own investment philosophy, here\u2019s what I came up with. And remember, you don\u2019t need to agree with me! The best investment philosophies are personal rather than copied from someone else.<\/p>\n 5 Principles of My Investment PhilosophyPrinciple 1: KISS (Keep It Simple, Stupid!)<\/p>\n This is my core belief: A minimalist approach to investment selection and portfolio oversight beats a more complicated one any day. Prioritizing simplicity points toward a portfolio of broadly diversified mutual funds, especially low-cost index funds and exchange-traded funds. It\u2019s straightforward to select such holdings and assemble them into a portfolio with your desired asset class exposures. Maintaining it is also simple. A thorough once-annual portfolio review, where you determine whether rebalancing is in order, will be plenty. This is the classic \u201cgood enough\u201d approach.<\/a><\/p>\n A side benefit of keeping it simple is that it enables you to ignore a lot of the noise in the investment world. I have a large and growing \u201ctoo hard\u201d pile<\/a>\u2014investments that just aren\u2019t worth the bother and might only have had a marginal benefit to our plan even if we owned them. I also happily ignore a lot of the financial news flow<\/a>. (Apologies, CNBC.) Whether it\u2019s the latest inflation reading or a hot IPO, it\u2019s unlikely to have a significant impact on my investments. I might pay attention because it affects the world we\u2019re all living in, but I would never adjust my portfolio in response to the news flow.<\/p>\n Principle 2: Maintain Ample Liquidity<\/p>\n While I am comfortable with heavy equity exposure in my portfolio, I also like the peace of mind that having a large-ish cash cushion affords<\/a>. Intellectually, I know that holding cash isn\u2019t great from an investment standpoint. While interest rates are higher today than they were a few years ago, cash yields are pretty thin gruel once you factor in inflation. Nonetheless, I consider cash to be a core luxury good at this life stage, allowing us to cover big-ticket outlays at a moment\u2019s notice while also feeling comfortable with our aggressively positioned long-term portfolio. We\u2019ve been deliberately adding to our fixed income holdings as retirement approaches (all of my new contributions have been going into bonds for the past several years!), but I know we\u2019ll also continue to carry an ample cash cushion because of the mental peace that it affords.<\/p>\n Get more insights in Christine Benz’s weekly newsletter, Improving Your Finances<\/a>Principle 3: Let Time Horizon Guide You<\/p>\n In a related vein, another of my core beliefs is that it makes sense to use anticipated spending horizon to guide what to invest in and how much risk to take. If you have a long time horizon (say, over 10 years), you can reasonably hold equities because it\u2019s been pretty rare for stocks to be down over that time frame: They\u2019ve landed in the black in more than 90% of rolling 10-year periods. But for shorter spending horizons, stocks are risky. That\u2019s where bonds and cash come in.<\/p>\n