The Investment Strategy

There are many paths to financial freedom.

Forward

Money is a lot like religion and politics, in that everyone believes they have the one truth. This makes for passionate conversations, but should not mean we avoid talking about or getting involved in investing, money and good money management.

There are many paths to financial freedom, you need to find the one that works for you. The one that fits your character (appetite for risk), your goals (take over the world) and your timelines (staring out in life or looking to put your feet up).

This document is written from the perspective of an Australian investor and outlines my philosophy, principles and thoughts behind investing.

Aim

The aim of this document is to outline guiding principles and a basic strategy for investing. So as to remove emotion and the Fear-Of-Missing-Out (FOMO) from the process. To have a system, to have a plan.

Introduction

The best way to make money, is not to lose money. So always protect the downside. This does not mean avoiding risk, because without risk there is no reward. It means understanding deeply what you are investing in and having a strategy to limit or protect the downside – aka risk realisation – to a level that allows you to sleep at night.

For every dollar lost, you need to double your next dollar to draw even. Understand your risk (downside) and limit the exposure.


Principles

Diversification, trade size and liquidity.

To predict the future is difficult. Therefore, knowing where to invest to minimise downside is difficult. A key principle in minimising downside is to avoid the concentration of risk. Diversification, trade size and liquidity within a portfolio is key to reducing the concentration of risk.

Diversification is about spreading investments across assets, markets and time. In trade sizes small enough, that if you lose a trade you do not go bust. And in assets you can easily turn into money if need be.

Do not try to time the market and the cycles, that is impossible but use risk mitigation to limit exposure to movements.

Assets

An asset is something that will have an increased value in the future.

Asset classes are groups of asset that show similar characteristics and behaviours within a market. Asset classes have their own cycles, and those asset cycles move within a broader market cycle and those market cycles move within time (How The Economic Machine Works by Ray Dalio). Like a moon that orbits around a planet that orbits around a sun.

To limit exposure to a particular asset class and its cycle, split your investments across different assets.

Additionally, to limit exposure to a particular investment. Have different investments within a particular asset. A good way to spread invests is through Exchanged Traded Funds (ETFs) that invest in a spread across an asset class.

Markets

Different markets have different political, social and industry forces.

Forces will influenced and shape markets differently and subsequently the assets within them. While we are very much a global economy, different markets will behave differently to the same event. Because they have varying exposure – aka leverage – to the event. Some markets maybe mining focused, some tech focused or manufacture focused.

To limit exposure to a particular market event split investments across different markets such as developing, developed, planned and free markets.

Time

The price of an asset is essentially the aggregate of what people think its future value will be.

People will generally buy an asset if they think the current price is less then what its future price will be. This means that large price movements typically happen because of unforeseen events, not factored into future prices. Such as government policy changes, wars or natural disaster. To buy the low then, you would need to be able to see into the future or see something that others do not.

To avoid having to time the market, split investment across time. This has the effect of averaging out price movements. Then re-balance your portfolio periodically so it does not get too far out of balance. This has the effect of selling the highs and buying the lows and avoid concentration of risk.

Liquidity

You cannot eat your assets.

Liquidity is the ease at which an asset can be bought and sold. An asset is only worth what someone else is willing to pay for it at the time you need to sell it. Just because you need to sell, does not mean there is someone else willing to buy. Therefore, if no one wants to buy what you have, it is not worthy much.

To avoid having to sell below assets value, because there are more sellers than buyers. Look for assets with a higher volume of trade.

Trade Size

You are going to get it wrong.

A negative 50% movement on 100% of your portfolio will have a greater overall effect then 50% movement on 5% of your portfolio.

To avoid big draw downs on your portfolio, limit individual trade sizes from the overall portfolio size.

It is also important to keep in mind that it is $40 round trip when placing a trade. So to make money on a $40 position, you need to see a +100% movement in the price.

To avoid chasing big movements, your trade needs to be big enough to offset the brokerage fees. However, your portfolio needs to be big enough relative to your trade that a draw down will not make you go bust.


Application

I am proposing to implement a variation of the All Seasons portfolio based on the work of Ray Dalio. With more weight towards bonds, as it appears we are moving into a more unpredictable market and debit accumulation (early 2018).

The below table shows the broad allocation between asset classes.

ASSETSALLOCATION
Bonds40%
Stocks30%
Cash20%
Commodities10%
TOTAL ASSETS100%

The below table shows a further breakdown of the asset classes with diversification across markets and investments.

ASSETSALLOCATION
Intermediate Bonds (AUS)40.0%
Cash20.0%
Australia ASX2006.0%
Australian Small Cap4.8%
Large Cap (US)4.8%
Mid Cap (US)4.8%
Emerging Markets4.8%
World (Ex-US)4.8%
Gold5.0%
Commodities (Ex-Gold)5.0%
TOTAL100.0%

References

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