4 Steps To Creating a Better Investment Strategy

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4 Steps To Creating a Better Investment Strategy

It goes without saying that any successful investment manager has a defined, quantifiable, and repeatable investment strategy. Many investors, however, leap from one investment to the next, putting little effort into developing and assessing their overall strategy.

The following guidelines can assist you in developing a long-term investing plan. Ideally, this would result in more consistent performance and will aid in the reduction of emotional investment choices.

Most significantly, it will aid in avoiding a dispersed portfolio of separate assets with no overarching theme or aim when seen as a whole. The four phases to developing an investing plan are outlined below.

Key Takeaways

  • Developing a successful, long-term investing plan requires the ability to articulate, convey, and document your approach – both for your own benefit and, if you are a professional, for the benefit of your clients.
  • Effective investors have views about why markets work the way they do, as well as tactics for profiting from those beliefs.
  • A solid investing plan must be weatherproof, or capable of operating in all market situations, even if it performs better in specific scenarios.
  • A functional investment strategy must be quantifiable in comparison to a major benchmark, such as the S&P 500; if the strategy repeatedly performs worse than the benchmark, it may be time to change things up.

1. Write It Down

The first step is to document your investing plan as a process. “If you can’t explain what you’re doing as a process, you don’t know what you’re doing,” said the late Dr. W. Edwards Deming, a world-renowned author and management quality consultant.

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It is critical to write down your investing plan, as with everything that involves a disciplined procedure. This will assist you in articulating it. Once you’ve created your plan, go through it to ensure that it aligns with your long-term investing goals. Writing down your approach provides you with something to fall back on in times of upheaval, allowing you to avoid making emotional investing choices.

It also provides something for you to evaluate and modify if you identify errors or your investing goals change. A documented plan can assist customers comprehend your investing approach if you are a professional investor. This may boost trust, reduce customer queries, and boost client retention.

2. Have Beliefs

You should have views about why assets become overvalued or undervalued, and how to capitalize on those ideas. This includes your belief in the efficiency of financial markets. Consider the following: “What distinguishes me from the market? What is the source of my competitive advantage?”

You may have unique industry expertise or access to research that few other investors have. You may also believe in taking advantage of market abnormalities, such as purchasing firms with low price-to-book ratios. Once you’ve determined your competitive edge, you must determine how to effectively execute a long-term trading strategy to capitalize on it.

Rules for both purchasing and selling assets should be included in your trading strategy. Also, bear in mind that your competitive edge may ultimately lose its profitability as a result of other investors using the same method.

On the other hand, you may think that investment markets are perfectly efficient, which means that no investor has a constant competitive edge. In this instance, investing passively in indexes is the greatest way to minimize taxes and transaction expenses.

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3. Make It Resilient

A critical component of any excellent investing plan is its ability to perform well in all market conditions. Good investment managers understand where their investment success originates from and can describe the strengths and flaws of their approach.

Many outstanding investing strategies will have periods of tremendous success followed by periods of lagged performance as market trends and economic cycles shift. Even if your approach is momentarily out of favor, having a thorough knowledge of its flaws is critical to preserving your confidence and investing with conviction. It may also assist you in identifying techniques that may complement your own. Combining value with growth investment techniques is a common illustration of this.

4. Measure It

It is impossible to enhance or completely comprehend something that cannot be measured. As a result, you should have a standard against which to judge the efficacy of your investing plan. Your benchmark should correspond to your investing aim, which should correspond to your investment approach.

Absolute and relative benchmarks are the two most popular forms of financial benchmarks. A passive market index, such as the S&P 500 Index or the Bloomberg US Aggregate Bond Index, is an example of a relative benchmark. An absolute benchmark would be a goal return, such as 6% per year.

Although it might be time-consuming, it is critical to examine the amount of risk you are incurring in relation to your investment benchmark. This may be accomplished by tracking the volatility of your portfolio’s returns and comparing it to the volatility of your benchmark’s returns over time. The Treynor Ratio and the Sharpe Ratio are more sophisticated risk-adjusted return measurements.

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The Bottom Line

Good money managers understand why assets are overpriced or underpriced and what drives their investment success. A well-planned investing strategy may assist to consistently provide long-term profits.

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