Defining your Personal Investment Philosophy: Why it’s important and the impact it has on your portfolio

Defining your Personal Investment Philosophy: Why it’s important and the impact it has on your portfolio

By: Carli Smith, CFP®, Wealth Management Advisor

All of us have a value system or a set of beliefs regarding the meaningful parts of our lives. Think back to how you developed your values and beliefs. As a child, they tended to reflect those of your family. As you grew into adulthood, your beliefs and values may have gone through a few variations depending on the point in life you were in, the experiences you went through, and the people you surrounded yourself with. The more educated you became and the more independence you gained, the more your value and belief system was independently shaped and developed.

The evolution of your personal investment philosophy is no different than any other set of beliefs or values you have. What exactly is an investment philosophy? In simple terms, it is nothing more than how you view the world of investing. To some, they believe they can beat the market. To others, they believe in a longer-term approach and controlling what is possible to control. I’ll explain this in greater detail soon. More times than not, your opinions and feelings on investing were initially shaped by your family experiences followed by your personal experiences and people you surrounded yourself with.

Developing an investment philosophy is very important for setting yourself up for success. If you aren’t sure where to start, you can think of investing in one of two ways. Do you think you can beat the market? Or, do you believe you have no control over the outcome?

Many investors think they can beat the market, which falls under the category of active asset management. The investor makes their decisions on the idea that they can predict what will happen. Having this philosophy can lead to emotional decisions rather than disciplined decisions which leads to added anxiety and undue risk. In fact, looking at almost 3,000 different equity mutual funds over a 15-year history, only 51% survived, and only 14% were winners, meaning they had greater returns than the market. The same is true of fixed income mutual funds. Clearly, the data shows that when you try to outwit the market, you are essentially competing with the collective knowledge of all investors, which leads to a poor outcome overall. It can be a stressful and costly way to handle your investments, which may not result in the outcome you desire.

If you believe you have no control over the outcome of the market, you might wonder what you can control and still have a positive investment experience. By focusing on your risk tolerance, how well diversified you are, the costs incurred, and staying disciplined, it can lead to a better investment experience overall. By harnessing the market’s power, you are putting the knowledge of all investors to work in your portfolio, rather than competing against it. If this is you, it is important to know, the way you should structure your portfolio and the financial advisor you decide to work with completely changes.

I have observed that most people start out thinking they can beat the market. Why? Because it’s exciting to think about. It’s depicted in every movie ever made about Wall Street. Because, in our basic business and finance classes, we are taught to try and buy low and sell high (aka market timing!). Some of the biggest asset managers in the world are primarily active asset managers who are marketing to investors that their investments can beat the market. The media is constantly in our faces about the best companies to invest in, the ones to sell, and the ones to hold on to. They thrive on the rollercoaster of emotions of the average investor. Eventually, this gets tiring and creates a negative experience which provides an opportunity to allow for a shift in your investment philosophy or core beliefs of how the market works.

No matter what your personal investment philosophy is, it is important to work with a financial advisor who shares that same philosophy. In a previous article, I mentioned it is one of the top questions to ask an advisor prior to working with them. Even if you are not sure what your investment philosophy is yet, ask a financial advisor what theirs is and how it drives the decision-making process for the portfolios they manage. Working with a financial advisor who shares your beliefs and values will ultimately lead to a successful relationship and hopefully lead to a positive investment experience.

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