Our Avidity to Invest, but Initium is Suss
The Path to Understanding your Own Investment Philosophy
“An investment operation is most intelligent when it is most business like.” ~ Benjamin Graham
Edited by Iris Roundtree Mitchell of MitchTree Productions
When I think about an investment operation while standing on Mr. Buffetts shoulders running his business operations, I have the eminent dead in mind first and foremost:
Imagine yourself on the shoulders of the financial genius named Warren Buffett. Also keep in mind other “value-minded” investors in history and borrow from Charlie Munger’s (here is a great synopsis on the man himself at Farnam Street blog complete with great links to dig into Munger) mindset about the eminent dead.
You have above a list of OGs, original geniuses, to develop a reasonable philosophy towards business and investing. They provide you a way of thinking for people who have found ways to be financially successful under intense adversity. And by repeating their life it is a model for an important basis and start around investing in the stock market.
On the other hand, if reading is too time consuming, lean into shared family stories; such as the grandmother or mother who was a peddler on the island of Jamaica selling “knick knacks” so that she may support her family. People also have deep embeds of lessons in the games played as adults to point us in how to invest in the stock market.
The Games We Play
Certainly we are dealt bad hands in card games like Texas Hold’em or Contract Bridge. In the Chinese game GO, you are given limited resources. In a childhood African based game, “Ouril” the Cabo Verde variation of mancala, you have to figure out how to collect limited resources quickly using quick mental math or you lose.
In these games, you enter with a degree of knowledge on what should be done. The best players are all trying to figure out what everyone else is not doing and exploiting their newly discovered edge to their advantage after knowing what the rules are.
Many people think the way markets work is unpredictable. But the coherent way of thinking about markets is to have a view about how humans learn; whether they learn too slow, too fast, or from the crowd.
There are many different investment philosophies that can help us make more educated decisions. The investment philosophy should be the starting point for any investment journey.
Of course all of this leads to the first steps in developing your own investment philosophy which sets a tone of asking questions, a kind of ascent of queries. We must follow them to their conclusions no matter what the cost or unpopularity of the result.
Basic questions our own investment philosophy asks:
1. What are the best available opportunity sets that will compound at the greatest annualized rate?
2. How do we know if the opportunity sets’ aggregate profits will exceed their aggregate losses?
3. What is the opportunity’s true economic worth?
Quick Musings on Philosophy
From time to time the word philosophy has had different meanings, and often reflects the culture of its time. We usually understand the word to refer to the love of wisdom, and it comes from the Greeks.
In this sense, as the famous philosopher Socrates apparently suggested, philosophers give the impression that wisdom is being sought rather than found. We would not call a person a physicist unless he had, say, knowledge of physics, but we would describe a philosopher as someone who pursues wisdom but does not necessarily achieve it.
On the other hand, philosophy also has the negative feeling of being an empty, speculative discipline, unnecessary for the practical activity of understanding things, and consisting mainly of unrelated or irrelevant theories.
However, philosophy, in its broadest sense, is the activity that people engage in as they seek to understand fundamental truths about themselves, the world in which they live, their relationship to the world, and to each other. Philosophers are constantly engaged in presenting, answering, and debating answers to life's most fundamental questions.
Philosophy asks:
1. What is there?
2. How do we know?
3. What is it worth?
To make such a pursuit more systematic, academic philosophy is traditionally divided into major areas of study. We believe our categorization below makes the pursuit digestible into two distinct areas of study. We found the Department of Philosophy at Lund University to have the best broad categorization on the branches of philosophy:
What is Theoretical Philosophy?
Theoretical philosophy studies the principles of human knowledge, the development of science and the basis for scientific knowledge, the principles of thought, argumentation and communication, the nature of language and consciousness, metaphysics, and the history of the subject itself. Some of the central issues for us are: What is knowledge and what is the difference between knowledge and information? What do logical thought and rational argumentation mean? What does it mean to think critically? What ultimately exists? What is causation? What characterises a scientific explanation? How should we change our views and theories in the light of new facts? What distinguishes typical human cognition and communication? What is verbal meaning? How does cooperation work?
In theoretical philosophy areas of relevant study for creating an investment philosophy we believe are epistemology, metaphysics, ontology and logic.
What is Practical Philosophy?
Practical philosophy can be defined as the study of the philosophical foundations of "practical thought", with a particular emphasis on values, attitudes to life and norms of behaviour. Lund’s practical philosophers have in recent years obtained external funding for a number of research projects, within various parts of the subject. The projects range over the following themes: philosophical theories of value, the concept of welfare, virtue and responsibility, practical rationality, theories of causation, collective action, the concept of intent, and dynamic decision-making. If one considers the research more generally within the subject at the department, there are five fields which currently attract the majority of research activities: moral philosophy, axiology (= theory of value), political philosophy, decision theory, philosophy of action and social ontology.
In practical philosophy areas of relevant study for creating an investment philosophy we believe are aesthetics, philosophy of law along with political and social philosophy (Corporate Governance,) and axiology.
Philosophy Ingrained as a Path to Investing
To invest successfully…In our view, though, investment students need only two well-taught courses - How to Value a Business, and How to Think About (Stock) Market Prices.
~ Warren Buffett in his 1996 Berkshire Hathaway Chairman’s Letter
For us we see the above quote as Buffett’s descriptive separation of how he views practical philosophy and theoretical philosophy when discussing investment philosophy. Buffett goes on to say,
Let me add a few thoughts about your own investments. Most investors, both institutional and individual (retail investors), will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals.
Should you choose, however, to construct your own portfolio, there are a few thoughts worth remembering. Intelligent investing is not complex, though that is far from saying that it is easy. What an investor needs is the ability to correctly evaluate selected businesses. Note that word "selected": You don't have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.
Another genius we follow, professor Aswath Damodaran at New York University, wrote the book Investment Philosophies and had this to say about the very first steps in developing your own investment philosophy.
If every investor needs an investment philosophy, what is the process that you go through to come up with such a philosophy? While this entire book is about the process, in this section we can lay out the three steps involved.
Step 1: Understand the Fundamentals of Risk and Valuation
Before you embark on the journey of finding an investment philosophy, you need to get your financial tool kit ready. At the minimum, you should understand:
How to measure the risk in an investment and relate it to expected returns.
How to value an asset, whether it is a bond, stock, real estate holding, or business.
What the ingredients of trading costs are, and the trade-off between the speed of trading and the cost of trading.
We would hasten to add that you do not need to be a mathematical wizard to understand any of these, and we will begin this book with a section dedicated to providing these basic tools.
What we are certain about is that to win in the market is neither an easy nor painless endeavor. In Financial markets, participants and agents operate within known and unknown information. Best judgments about the value of assets are applied. It's not uncommon for them to be wrong, and even those who believe markets are efficient admit this. This goes for the best of professionals, including Warren Buffett.
However, do you believe you are capable in beating the vast informational resources in operation and take advantage of their lapse in judgement and do better than the average investor or institutional investment manager? To do so requires vast amounts of due diligence homework, humble enough to understand the weaknesses in your investment philosophy, and work to protect against them. Should your investment philosophy time frame rely on short duration to play out, you will need lots of luck on your side.
And that is to say about an investment philosophy, no matter how well thought out and designed one might be, no investment philosophy will work for you if you don’t know yourself.
An investment know-how is with attention to ones' preferences and characteristics in regards to:
risk appetite
investment horizon
asset allocation
position/bet size.
Professor Damodaran has these two tests to help especially investors of moderate assets:
a. An acid test: If you constantly worry about your portfolio and its movements keep you awake at nights, you should consider it a signal that the strategy that you just adopted is too risky for you.
b. The patience test: Many investment strategies are marketed as long term strategies. If you adopt one of these strategies but you frequently find yourself second-guessing yourself and fine-tuning your portfo- lio, you just may be too impatient to carry this strat- egy to fruition.
In the long term, not much that is good—either physically or financially—comes out of these mismatches.
~Professor Aswath Damodaran in Investment Fables: Exposing the Myths of “Can’t Miss” Investment Strategies
Tenet: No single investment strategy fits all investors.
Key Lesson: Know Yourself
We said earlier that “the best players are all trying to figure out what everyone else is not doing and exploiting their newly discovered edge to their advantage after knowing what are the rules.” We would add that elite players have this important form of intelligence in knowing how to read people but go further in excelling on their ability to understand oneself. Reading this recent research paper titled “Teaching Philosophy Through a Role-Immersion Game: Reacting to the Past,” will help in gaming out you putting yourself in the shoes of a Mary Ellen Pleasant as you read her biography and game out her philosophy and your own philosophy. Don’t forget the others though or the ones you find yourself.
ACKNOWLEDGEMENTS
Edited by Iris Roundtree Mitchell of MitchTree Productions