Investment Process by Heuristics

Abstract

This comprehensive exploration of the investment process delves into the collaborative efforts of investors, financial advisors, and analytical tools at each stage. From establishing investment policies to navigating markets and instruments, the iterative nature of the process allows for continuous adjustments and optimization over time. The article features insightful quotes from renowned figures like Warren Buffett, Benjamin Franklin, and Benjamin Graham, underscoring the timeless principles that guide successful investment practices. It emphasizes the importance of applying accumulated wisdom, cultivating a disciplined approach, and reflecting on the perspectives of great investors to shape a well-informed and thoughtful investment philosophy.

Time to Read: Approximately 5 to 7 minutes.

Level: Fundamental.

Category: Education Note.

The investment process is a methodical series of steps designed to guide resource allocation towards achieving financial objectives. One pivotal element involves applying the accumulated wisdom derived from decades of experience by renowned investors. This simple guide serves as a framework for conducting a comprehensive analysis of each step in the investment process. By emphasizing the importance of incorporating the insights and lessons learned over time, the guide encourages a thorough examination of the decision-making process, risk assessment, and strategic execution. The goal is to ensure that each stage of the investment process is scrutinized against the backdrop of historical knowledge and seasoned perspectives, thereby enhancing the overall effectiveness and resilience of the investment strategy..

Stages, Actions and Key Participants of the Investment Process:

The investment process encompasses a series of distinct stages, each with its own set of considerations and key participants:

1. Investors:

   • Profile: Understanding investors involves assessing their risk tolerance, time horizon, and liquidity needs.

   • Biases: Identifying and addressing behavioral biases that might influence decision-making.

   • Objectives: Defining clear financial goals and aligning them with the investment strategy.

   • Education: Evaluating the investor's financial literacy and knowledge about investment products.

2. Financial Advisor:

   • Providing guidance on investment strategies and portfolio construction based on the investor's profile.

   • Addressing investor concerns and ensuring a transparent communication process.

   • Offering insights into market trends and potential opportunities.

3. Investment Policy:

   • Establishing a comprehensive investment policy that aligns with the investor's goals and risk tolerance.

   • Defining asset allocation parameters and acceptable risk levels.

   • Setting guidelines for periodic reviews and adjustments.

4. Markets and Instruments:

   • Analyzing various financial markets and instruments available for investment.

   • Assessing the risk-return characteristics of different asset classes.

   • Evaluating market conditions and identifying potential opportunities or threats.

5. Financial Analysis (Technical and Fundamental):

   • Conducting technical analysis to assess market trends and price movements.

   • Performing fundamental analysis to evaluate the intrinsic value of securities.

   • Integrating both analyses to form a comprehensive view of investment prospects.

6. Investment Management (Asset Allocation, Security Selection, Rebalancing):

   • Determining the optimal asset allocation based on the investment policy.

   • Selecting individual securities or investment products aligned with the chosen strategy.

   • Regularly rebalancing the portfolio to maintain the desired risk-return profile.

7. Investment Decision (Integrating All Previous Elements):

   • Integrating insights from investor profiling, financial analysis, and investment management to make informed decisions.

   • Ensuring alignment with the established investment policy and objectives.

8. Orders and Execution:

   • Implementing investment decisions by placing orders through brokerage platforms.

   • Emphasizing timely and efficient execution to capture desired market conditions.

9. Performance Attribution:

   • Evaluating the performance of the portfolio against predefined benchmarks.

   • Attributing performance to specific investment decisions and market factors.

   • Providing feedback for continuous improvement and strategy refinement.

Investment Process | Source: Acekias

Each stage involves collaboration between investors, financial advisors, and various analytical tools to ensure a systematic and well-informed investment process. The iterative nature of the process allows for adjustments and optimization over time.

Informed Investment Process through Simple Heuristics:

1. Investors:

• "The stock market is a device for transferring money from the impatient to the patient." - Warren Buffett

• “An investment in knowledge pays the best interest.” — Benjamin Franklin

• “I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.” — Warren Buffett.

1. Financial Advisor:

   • "A good financial advisor will tell you what you need to hear, not what you want to hear." - Warren Buffett

   • "The goal of a financial advisor is to keep clients focused on their financial goals and encourage them to ignore the noise of the market." - David Dreman

   • A skilled financial advisor brings clarity to the complexity of personal finance, guiding clients to make sound decisions in an ever-changing financial landscape." - Liz Davidson

2. Investment Policy:

   • "The purpose of an investment policy is to remove emotions from decision-making and foster a disciplined approach to wealth creation." - Benjamin Graham

   • "A well-crafted investment policy statement instills discipline, accountability, and a long-term perspective in the investment process." - William J. Bernstein

   • "Investment policy is the strategic plan that transforms financial goals into actionable steps, making the journey towards wealth creation more intentional and successful." - Ray Dalio

3. Markets and Instruments:

   • "In investing, what is comfortable is rarely profitable." - Robert Arnott

   • "The market is a device for transferring money from the impatient to the patient." - Warren Buffett

   • "Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble." - Warren Buffett

   • "The market is designed to humble you every day." - Marty Schwartz

   • Bull markets are born in pessimism, grow in skepticism, mature in optimism and die in euphoria. John Templeton.

4. Financial Analysis (Technical and Fundamental):

   • "In the short run, the market is a voting machine, but in the long run, it is a weighing machine." - Benjamin Graham

   • "The stock market is filled with individuals who know the price of everything, but the value of nothing." - Philip Fisher

   • "It's not whether you're right or wrong that's important, but how much money you make when you're right and how much you lose when you're wrong." - George Soros

5. Investment Management (Asset Allocation, Security Selection, Rebalancing):

   • "Diversification is protection against ignorance. It makes little sense if you know what you are doing." - Warren Buffett

   • "The key to successful investing is to have everyone else be wrong at exactly the same time." - John Templeton

6. Investment Decision (Integrating All Previous Elements):

   • "The essence of investment management is the management of risks, not the management of returns." - Benjamin Graham

   • "The four most dangerous words in investing are: 'This time it's different.'" - John Templeton

   • "In any moment of decision, the best thing you can do is the right thing, the next best thing is the wrong thing, and the worst thing you can do is nothing." - Theodore Roosevelt

7. Orders and Execution:

   • "The goal of a successful trader is to make the best trades. Money is secondary." - Alexander Elder

   • "The more you practice, the better you get, the more confidence you have." - Ray Dalio

8. Performance Attribution:

   • "In investing, understanding performance is key to refining strategy and achieving long-term success." - John C. Bogle

   • "In investing, what gets measured gets managed." - Peter Drucker

   • "Successful investing is about managing risk, not avoiding it." - Benjamin Graham

These quotes distill the profound wisdom and insights of renowned investors, offering valuable guidance across diverse stages of the investment process. Even if your financial education is rooted in common sense, which is inherently valuable, you can further enrich your understanding by contemplating the perspectives of great investors. Reflecting on their ideas allows you to cultivate your own unique investment philosophy, shaping a more informed and thoughtful approach to wealth management.

• Warren Buffet is one of the most successful investors of all time, who runs Berkshire Hathaway, a conglomerate that owns dozens of companies. He is known for his value investing approach, which seeks to buy undervalued stocks and hold them for the long term. He is also a philanthropist who has pledged to donate most of his wealth to charity.

• Benjamin Franklin was an American polymath, a leading writer, scientist, inventor, statesman, diplomat, printer, publisher, and political philosopher. He was also a savvy investor who accumulated a fortune through his businesses and inventions. He advocated for frugality, industry, and compound interest as the keys to wealth creation. He also donated generously to public causes and institutions.

• David Dreman is an investor and founder of Dreman Value Management, an investment company. He is a pioneer of contrarian investing, which involves buying stocks that are unpopular or out of favor, and selling them when they become popular or overvalued. He has published many scholarly articles and books on contrarian investing and behavioral finance.

• Liz Davidson is the founder and CEO of Financial Finesse, a company that provides financial education and wellness programs to employees. She is a leading expert and advocate for financial literacy and empowerment. She has written a book called What Your Financial Advisor Isn’t Telling You, and has testified before Congress on financial issues.

• Benjamin Graham was an economist and professional investor, who is widely regarded as the father of value investing and security analysis. He taught at Columbia Business School and mentored many famous investors, including Warren Buffet. He wrote two influential books, Security Analysis and The Intelligent Investor, which laid the foundations for modern portfolio theory and fundamental valuation.

• William J. Bernstein is a neurologist and co-founder of Efficient Frontier Advisors, an investment management firm. He is also a prolific author and researcher on topics such as asset allocation, modern portfolio theory, and financial history. He has written several books for individual investors, such as The Four Pillars of Investing and The Investor’s Manifesto.

• Ray Dalio is the founder and chairman of Bridgewater Associates, the world’s largest hedge fund firm. He is known for his macroeconomic and global perspectives, as well as his unique culture of radical transparency and meritocracy. He has developed a set of principles for life and work, which he has shared in his books, Principles and The Changing World Order.

• Robert Arnott is the founder and chairman of Research Affiliates, an asset management firm that develops innovative investment strategies and tools. He is a pioneer of smart beta, factor investing, and asset allocation. He has published over 130 academic papers and edited three books on equity management and tactical asset allocation. He is also the creator of the Fundamental Index approach to investing.

• Marty Schwartz is a Wall Street trader who made his fortune trading stocks, futures, and options. He is famous for winning the U.S. Investing Championship in 1984, and for his book, Pit Bull: Lessons from Wall Street’s Champion Day Trader. He is known for his aggressive and disciplined style, as well as his use of technical analysis and market psychology.

• John Templeton was a legendary investor and philanthropist, who founded the Templeton Mutual Funds and the Templeton Prize. He was a pioneer of global investing, who sought opportunities in countries and industries that were at “points of maximum pessimism”. He was also a visionary who supported research and exploration on the big questions of science, religion, and human purpose.

Recommended Reading to Learn More on Related Topics:

• Bloch, Robert L. The Warren Buffett Book of Investing Wisdom: 350 Quotes from the World’s Most Successful Investor. New York: Skyhorse, 2021.

• Housel, Morgan. The Psychology of Money: Timeless Lessons on Wealth, Greed, and Happiness. Harriman House Ltd, 2020.

• Kratter, Matthew R. A Beginner’s Guide to the Stock Market: Everything You Need to Start Making Money Today. Independently published, 2019.