Unfortunately I have not found a straightforward investor curriculum to follow to reach my goal on a straight path. Virtually unlimited resources provide great advice, useful ideas and concrete strategies – but this is dwarfed by the amount of noise, useless and very expensive information (not necessarily because it costs a lot, but because it leads to losses) out there.
I find it quite problematic that, in the field of investing, there are different schools of thought that often claim to be exclusively right and condemn other approaches as bound to fail. Quite often combining different historically successful investment strategies will lead to superior results, especially when the approaches are based on opposing principles, because of the resulting diversification benefits.
In addition a lot of the material on investing and trading as well as financial news, do not have the purpose or incentive to make you a more successful investor, but are largely designed to grab your attention and to sell investment and trading products to the public.
All that is not very useful for an individual investor.
We will need to find a way to focus to succeed.
I try to keep an open mind about all possibilities to achieve high, sustainable capital growth, while accounting for the risks taken. Labels like investor or trader, technical or fundamental analysis, academic or practitioner are counterproductive because they narrow our vision and mind unnecessarily. One of the greatest advantages an individual investor has, is to be able to stay flexible and unconstrained in his approach.
There are plenty of examples of historically profitable strategies from different realms. For example value and momentum investing (a fundamental and a technical approach, that both have shown historic outperformance virtually everywhere) are really two sides of the same process: a medium term overreaction in the market is followed by a long term reversion towards fundamental value.
To exclude an area of investing on the grounds of philosophy, not profitability, is – in my mind – not a smart thing to do, yet it is common practice. Few resources bring together different areas of investing and trading productively. But doing just that can cancel out disadvantages and enhance advantages of different approaches in practice, which is the essence of a well diversified portfolio.
How to separate the wheat from the chaff?
I use a set of criteria (detailed in chapter 4) that all investing or trading ideas have to pass before being included in my investment plan. These criteria don´t judge where an idea is coming from, but are based on historic evidence whether the approach has worked in the past and an analysis of the likelihood that it will continue to do so. Are there sustainable reasons for a strategy to provide long-term superior risk-adjusted returns?
I highly recommend to start the process from the top down.
Research ways to build a solid portfolio allocation with realistic positive return expectations – a classic buy and hold portfolio of different broad-based financial assets. Look at asset allocation models and start from here as the basis of your portfolio.
Always take care to invest with fees as close to zero as possible – ETF offer a tax efficient way to build this basis, often with no trading commissions.
Approaches that are less likely to lead to success.
The more common way is to start from the bottom up, learning how to analyze and pick individual stocks. In my experience the lack of an allocation plan often leads to a ragtag collection of stocks in areas that are the flavor of the month or part of a personal interest and not to a well constructed portfolio diversified across asset classes.
Loss aversion (failing to take losses early) often leads to a group of underperforming stocks populating the bottom of our portfolio. These positions are deep in the red and play no constructive role. Rather they cause clouded vision and are a great hindrance to reaching a smart, profitable portfolio allocation.
Over-optimistic confidence in our stock picking abilities will lead to concentration in areas we are convinced will outperform – real probabilities for superior performance are likely much lower than we anticipate.
Even more enticing is to start with unrealistic return goals, using the latest (day-) trading strategy. Most of the time that proves to be very costly, rather than a quick and easy road to financial independence.
Moving from a broad overview of well-founded investment knowledge to researching more specific strategies within that framework, avoids a lot of the confusion that hyped strategies or detailed security selection tend to bring.
Stopping at a well diversified buy and hold portfolio would be no bad thing at all, but limiting portfolio construction to classic allocation concepts leaves alternative return streams and diversifiers on the sideline. Many people disagree with this, so it is important to make up your own mind. It is only possible to be successful when you trust your own approach, otherwise it will go out the window at the first sign of trouble.
continue with part 4: Criteria and examples of useful strategies