The 4 Keys to a Good Investment Process

2017 2Q earningsPeople are worried that people aren’t worried enough.” That’s the phrase Matt Levine has used to describe the current state of the stock market, or rather many investors’ thoughts on the stock market. What he means is that the stock market has been calmer for a longer period of time than it usually is, and though there are no blatantly obvious reasons for this to discontinue (nuclear war notwithstanding), people are getting antsy in the same way I might get antsy not hearing anything from my two-year old son in his room for longer than about 45 seconds.

Now, there are solid cases to be made for some of the worry, many of which revolve around stock valuations being high on a relative basis. In other words, this long and nonvolatile bull run is more parts investor sentiment than actual company earnings and fundamentals. Eventually and probably soon, the thinking goes, the prices must revert and we’ll experience one of those not very fun yet necessary and expected events called a correction.

The problem is that stock prices aren’t beholden to arguments, even ones based on solid evidence, in the short term. Some people have been saying “eventually and probably soon” about the next correction for a number of years now, and it would be pretty disappointing to have listened to those people and gotten out of the market. Furthermore, despite the solid evidence of an imminent correction due to high valuations (again, prices coming down to the earnings), we are now going through one of the better earnings seasons in years (i.e., rather than prices coming down to earnings, some earnings are perhaps catching up to prices).

So you see, being an investor is hard, because there is always some countervailing evidence to your position, and being right counts for very little in the first place if you aren’t also being patient. And being patient is impossible if you don’t have an investment process in place.

An investment process is a thorough, evidence-based plan that sets you up for success in the best way possible, defining success as the achievement of the financial goals you have set for you and your family.

But many people walk around with only a vague idea about their investment portfolio, much less a defined process, so I thought I’d outline at a high level what I think a good process entails.

  1. Know why you own the assets you own. Every piece of a portfolio should play a very specific role, that you understand, that is based on rigorous evidence. This is why in almost every case financial planning and investment management should be thought of as two sides of the same coin. Without the planning there’s no way to know what role an asset should play, and without the investment management, there’s no way to implement the plan.
  2. Seek to take an appropriate amount of risk. If step one is understanding which assets you will allocate to, step two is understanding how you will allocate them. The primary decision here is understanding how much volatility (represented principally by the equities you hold) is appropriate to achieve your goals while making sure you hold enough high-quality bonds to help you sleep better at night. We know from behavioral research that human tolerance to investment risk changes with fluctuations in the market, so this is something that needs to be revisited regularly.
  3. Have rules for trading. Never make a trade based on emotion. If we could all live by that simple rule we’d have a great deal more success as investors. But the only way to do that is to have quantified rules in place ahead of market turmoil that drive any trade as if a robot was making the decision rather than a human. For example, here at Beacon we have tolerance bands around our portfolio positions that serve as the basis for rebalancing accounts. We don’t make emotional decisions about trading because we built a process for the express purpose of not making emotional decisions about trading.
  4. Have someone to talk to. One of the chief roles of a financial advisor is to be what Nick Murray called a “behavioral investment counselor.” Someone who is present in times of turmoil as an advocate for your success. Sometimes this means talking you in off the ledge of a bad financial decision, but mostly it’s encouragement to stick with the process that’s been put in place because the process was built specifically for you, by them.

Who knows whether people are worried “enough” about the stock market. Perhaps yesterday’s slight sell-off will make them worry more. But while it’s impossible to eliminate worry altogether, one of the chief benefits of a solid investment process is to put you on a path toward success while simultaneously requiring less of your emotional energy. So if you’re looking at your portfolio and thinking it doesn’t really have a good process, and if you’d like to worry a bit less about your money, give us a call. That’s what we’re here for.


Jared Korver
[email protected]

A product of small-town North Carolina (Carthage, to be exact), I’m proudly married to my best friend and co-adventurer, Amy. Together, we have two sons–Miles and Charlie–and could more or less start a library from our home. I love being outside, can’t read enough, am in the habit of writing haikus, and find food and coffee to be among life’s greatest treasures.