Building a New Investment Process

·

Investing has a few basic truths we should accept: strategies require time and human nature often acts against our best interests.

Time is a dual problem – time required to do the work and time for the strategy to work. I’m dealing with the former which is the point of this post.

I’ve flirted with the idea of changing strategies over the past year. A lack of time gives me the excuse to move forward.

My goal is to find a similar value-oriented strategy that takes up less of my time. The only thing I’ve found is to automate more of the decision-making process.

A good sense of self is required to find a strategy that fits. You need to know your quirks, biases, comfort level, etc. that reinforce good and bad decisions. Brutal honesty helps. I can claim the ability to buy falling stocks, but if I’ve never done it before, it’s unlikely I’ll do it when it matters. Luckily, I’m comfortable buying things falling in price, almost too comfortable (another reason for rules).

Our decision-making process is flawed in respect to investing. For instance, we gravitate toward what works now instead of what works best over time. This is why trying to time anything is a recipe for disaster. When you toss in all the other biases and bad tendencies it’s the actual decision-making process that falters. So fewer decisions are better.

All of this means building out a set of rules. The ultimate goal is to take what I know works for me, simplify it, and systematize it to reduce decisions because decisions are where most mistakes are made.

Here’s what I’m looking for: Value matters most. Quality matters next. I’m looking for total return. Whether it comes from capital gains, dividends, or both, it doesn’t matter. Finally, it must be a simple set of rules.

There are several ways I could go about this. For instance, I could define value as a low P/E or low P/B, but I’m leaning towards EV/EBITDA. Quality can be found via shareholder yield, low debt/equity, free cash flow (FCF), and return on investment (ROIC).

The rules will set the limits and make decisions. Stocks that fit the rules are in, those that don’t are out. It’s that simple. If you’ve read The Little Book that Beats the Market, or know about Greenblatt’s Magic Formula, this would be similar.

Of course, this exercise is pointless if I can’t follow the process during good times and bad. Even second guessing the process isn’t an option.

Greenblatt actually studied people using his process and found that most underperformed his system. Go figure. We think we’re smarter than a few simple rules.

The reason simple strategies work is because they can be repeated over and over again regardless of what the market is doing. Problems arise once the focus turns away from the process and onto other things, like short term results.

So it’s important to pick a set of rules that I’m comfortable with all the time. The rest comes down to discipline.

I’m still working out the rules. Once done the portfolio will own a concentrated basket of stocks and rebalance after a year. The process should free up more time and take human nature out of the process as long as I follow the rules.


Get more weekly wisdom.

Sign up for my weekly newsletter. Join 1,000s of readers and never miss a post.

Newsletter Subscribe Form

Work with Me

Financial Planning

Investment Management

Portfolio Review