Behind the TIB Investors Journal #4 - What's the Investing Strategy?

I have written a lot about investing and trades. Bigger question is how to invest? How to save? What is the strategy?

In this post I will take a step back and lay out some guiding principles for constructing an investing strategy. I am going to throw all the spaghetti on the ceiling and see what sticks - it will be different for each one of you.

A good place to start is to Google "How to Invest" and see what comes up - skip the ads at the top of the page. I have picked 3 and I will digest what comes out of them in terms of criteria, strategies and approaches

We are going to learn about time and risks and earning power (mostly called returns). Let's go with this article from Forbes Magazine, a leading source for reliable business news and financial information (they say).

https://www.forbes.com/sites/robertberger/2015/10/31/how-to-invest-for-the-very-first-time/#70920b7a6a34

The article is based on interviews with a few first time (young) investors. It distills 4 things to worry about

1. Time - when do you need the money back? If time is short - invest in savings accounts; if time is long invest in stocks
2. Diversification - Without saying so this is about how much risk you can afford to take? Risk and time are linked - the more time you have the more risk you can take. The main thesis here is to diversify with a mix of bonds and stock depending on your time frame
3. Cost - how much will it cost to manage the money? A small cost multiplies out over a long time frame. The less you have to invest the more the cost factor features
4. Ease - how much effort does it take to make investments and to track them?

That makes for a tidy list of criteria - time, risk, cost, ease.

In the next article, "The people with money are investors" as a tagline caught my eye.

https://www.moneyunder30.com/how-to-invest

The big thought here is to

learn to devote your limited resources to the things with the largest potential for returns. That may be paying down debt, going back to school, or fixing up a two-family house

The elements to consider are

1. Risk vs return.
2. Time
3. Diversification
4. Ease and costs

The core idea is to start early on using your limited resources well. Step one is to build the disciplines to set aside some spare stuff AND it is not just money that can be spare. Time too can be used as a spare resource - e.g., working a part time job; using spare time to make craft things to sell online; doing online marketing when you get home from school

Once you begin just keep building and make today's earnings grow and compound into tomorrow's savings.

This next article starts with a 10 Second Summary - easy stuff.

http://www.wikihow.com/Invest

1. Build up some emergency funds and pay off any high-interest debts
2. Set your goals and don't be afraid to take risks. Keep your investments diverse
3. Invest in companies you understand. Buy low and sell high
4. Open a savings account and invest in stocks
5. Consider some riskier bets, such as real estate or currencies.

Diversification is a strong element of each of these articles. The idea is to keep adding different investments to reduce the overall risk of your portfolio to a bad outcome on any one of the investments. This is the whole concept of Modern Portfolio Theory. Construct a portfolio that only carries the risk of the market and diversifies away the risk of individual instruments.

There is also a lifecyle thread running through these ideas. Start building your retirement capital early in life. Take more risk the more time you have. As your income grows allocate more and more spare cash to investing. As the grey years approach start reducing the riskiness of the investing because there is not enough time to recover from a disaster. This approach brings together time and risk into one strategy.

There is a different way to think about diversification and time. Rather than thinking about a continuum of risk from less risky to very risky think only about the extremes - low risk and high risk. The idea is to allocate a big slice of your investments to the low risk end to cover your spending and emergency needs and allocate a small portion to the risky end to offer a disproportionate payoff - the so called Barbell Strategy invented by Naseem Taleeb in his book Antifragile.

An example would be to invest 80% in Government Bonds and 20% in Growth Stocks which could deliver the same returns as a diversified portfolio of stocks. At first blush in a normal cycle both portfolios might return the same. The Barbell portfolio will carry less risk in the event of a debacle affecting stocks - because only 20% of the portfolio is affected.

Here is an excellent article that covers the theory and (dated) examples.

http://www.walnuthilladvisorsllc.com/investing-101/investing/asset-allocation-theories/barbell-theory/

An updated version of the article deals with the low interest rate environment the world is in now.

The basic model would be to increase the risk at both ends, say use a managed portfolio of stocks and bonds at the low risk end and go more asymmetric using things like options at the high risk end.

You can think of the Barbell Strategy a little differently if you have a solid job and you have your emergency needs covered (by spare cash or insurance or social security or borrowing potential). Think of this as the safe end of the Barbell as life's needs are covered. The risky end of the barbell can now be bigger and it can have more risk - maybe layered levels of risk

In my next article, I will start to walk through my investing journey so you can see what worked for me and you can explore how things differ depending on stage of life and market conditions and emotional state.

Images: I own the rights to edit the price chart image. Other images are credit below the images.