I had a real light bulb moment today. You know the one where a picture shows a fully illuminated light bulb above a cartoon head. That was me. And it was to do with investment philosophy and strategy. Weird, eh.
These were concepts I had not given much thought about. I knew what I did, and I knew why I did it, but it hadn’t been articulated quite as clearly with neat headings and clarity.
I discovered that talking about and recording our investment philosophy and strategy firmly sets about how we will reach financial sustainability. That’s the point where our investments create enough income to live off and working is optional.
Your investment philosophy relates to your personal investing preferences, which are informed by your beliefs. In Australia, the cultural bias is towards real estate investing.
How well do you know thyself? How much risk are you willing to take; how complex; how involved; do you have a little or a lot of spare time to commit to investing?
Perhaps your preference is real estate, a day trader of shares, putting money into cryptocurrency, P2P lending, gold or any manner of investing for income whether it is actively or passively earned.
For example, day traders use the stock market to buy and sell shares as a short term holding, rather than a long term investment. It’s an investment philosophy about buying and selling financial instruments with the aim of closing out of the positions by the end of the day to profit from small movements in price.
Whereas, if your preference was P2P lending, then you’d believe in debt financing so people can borrow money from other people (such as yourself) through an online platform without using a traditional bank.
However, if cryptocurrency appeals to you, maybe the fact that they are generally not issued by any central authority (making them theoretically immune to government interference or manipulation) is more inline with your preferences.
For us here at Sustainable Living, our investment philosophy is in low cost index funds in the share market. We keep it simple. We don’t try and pick individual securities, or time the market. Our investments are long term in both stocks and bonds with the goal of producing a passive income to fund our retirement. This is how we aim to be financially sustainable.
If the philosophy is the what, then the strategy is the how. Earlier in the year, we covered the why.
For someone with a real estate preference, the strategy then comes down to the type of real estate: residential or commercial, short term such as AirBNB or long term leases, new or used, rent or renovate and sell. How many houses, units, shops, factories, farms? What would be the trigger to buy more real estate? Will you use something like the one-percent rule?
With P2P lending would you loan to someone to buy a new boat or consolidate their loans, how many prior defaulted payments would make it unacceptable for a loan from you, are you going to stick with AA rated notes or would you lend to a B or C rating?
Because our strategy is index funds it keeps things simple. It is based on three categories:
- Equities (shares)
- Bonds (fixed income)
The cash part relates to having an emergency fund, also known as FU Money. This money is a safety buffer in case of major negative financial events such as a bear market early in retirement, or losing your job, or just being in a crappy situation that you need to get out of quickly.
Our strategy is to have one year of living expenses in cash in a nice safe term deposit by the time we reach financial independence and can retire from the work force.
Next, is an allocated percentage between equities/stocks and bonds. Stocks are more volatile yet have a greater potential for gains, whilst bonds are steady. By having diversification with stocks and bonds it ‘smooths the ride’ of the ups and downs of the stock market.
As we are early in our accumulation phase of investing, we have chosen an aggressive 90% in stocks and 10% in bonds. This suggests a higher risk tolerance than someone more invested in bonds.
The reason we are okay with this tolerance level is because even though we will face a bear market (like now) we know that if we stay the course and keep purchasing, especially whilst the price per unit is low is that we stand to make much in gains.
Closer to retirement, we will rebalance our portfolio more in favour of bonds. Although to what percentage, we have not yet made a firm decision. Jack Vogel (the founder of Vanguard) recommends 50% in a stock index fund, and 50% in a bond index fund. For comparison, have a read of the JL Collins article on asset allocation in his Stock Series or the Barefoot Investor’s Idiot Grandson Portfolio.
At this stage, we are still forming a strategy for approaching the post-retirement phase. It tends to be around 60 – 70% in stocks and 30 – 40% in bonds.
Your Philosophy and Strategy
Your investment philosophy and strategy will be different from our investment philosophy and strategy. This is because you will have your own beliefs and preferences towards investing. Each person’s life circumstances are unique and this influences their choices.
For example, even within only investing in low cost index funds, some people are completely comfortable with 100% in equities post-retirement, whilst others only feel okay with 100% in bonds. Others, such as ourselves aim for a mixture of index fund stocks and bonds.
Another person will stay away from the share market and invest only in bricks and mortar, yet others go for P2P lending or cryptocurrencies.
We are all uniquely individual.
What is your investing philosophy and strategy? Please share below in the comments.
Disclaimer: I am not a personal finance adviser. Do your own research and contact a professional as needed. Tread your own path.