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The Error-Proof Portfolio: Why You Need an Investment Philosophy

Having conviction in your belief system can help you act with discipline.


"Strategy comes from philosophy. If you don't have a philosophy, you can develop a strategy, but it's only going to blow apart the next time it doesn't work for a month or two. And you are going to go onto another strategy, and that's the worst thing you can do."

Author and investment manager Rick Ferri made that comment in an interview with me late last year, and the conversation stuck with me. The most surprising part of our discussion was that Ferri, a dyed-in-the-wool indexer, believes that investors don't necessarily need to use passively managed investments for their portfolios. He noted that your philosophy could be that you can pick out active managers who can outperform, that you could index, or that you can adjust your portfolio's asset allocations tactically over time. What's really important, he said, is that you have a philosophy that makes sense to you and that you believe in--and that you then create a strategy which you would execute with discipline.

My interactions with hands-on investors and observations of professional money managers corroborate Ferri's views. As much as pundits might dogmatically espouse one investing philosophy or another--making it seem like it's their way or the highway--there are thousands of investment philosophies--and in turn strategies--that can help investors reach their goals. If you believe that dividends are king and that high-income stocks are all you need for your retirement plan, well, that's not exactly the way I would do it, but it's not unreasonable, either. If you believe in keeping it simple and want to limit your holdings to a single, well-diversified fund like  Vanguard Balanced Index (VBINX) rather than messing with a portfolio full of individual investments, more power to you.

The reason multiple philosophies can work out well is that inherent in having a philosophy, or belief system, is that you have conviction in it. And if you have conviction in something--whether it be central tenets you use to oversee your investment portfolio, your religion, or your belief that Morgan Freeman is the world's greatest actor--you're more likely to stick with it in good times (The Shawshank Redemption) and bad (Outbreak). That kind of discipline, not so much the philosophy itself (provided, of course, that the philosophy isn't completely kooky) is the key to an investment plan that will get you to your goals.

For example, a healthy contingent of retired investors believes in dividend investing--focusing on companies that kick off high and growing increasing of current income. (That's the philosophy espoused by my colleague Josh Peters.) My view is that in addition to owning dividend-paying stocks, most retirees need some bonds to tide them through periods when stocks underperform. But many retired dividend enthusiasts tell me they don't see it that way. As long as their companies continue to crank out reliable dividends, they're not bothered by gyrations in their principal values and they see no need for bonds. That's the kind of philosophy and conviction will lead people to a successful outcome.

Here are some key steps to take to arrive at a philosophy that works for you--and to develop a strategy you can stick with through thick and thin.

Know Thyself
The best way to arrive at a philosophy that you can adhere to is to get familiar with some of the big, basic decisions that confront investors: whether to index or go active, whether to take a strategic (that is, long-term and hands-off) approach to asset allocation versus one that's more tactical, whether to invest in individual stocks or funds, or whether to shade your portfolio toward value stocks or growth. Reading up on the research in these areas may sway you in one direction or another, but so will thinking about your disposition and core beliefs, as well as how much time you have to devote to your investments. Are you naturally thrifty in your personal life? Then a low-cost, no-frills, tax-conscious indexing strategy could appeal. Do you enjoy debunking conventional wisdom and eschew anything that smacks of trendiness? Then a contrarian, value-centric strategy could suit you just fine.

Remember that your investment philosophy needn't be black or white. For example, you could invest the bulk of your money in index funds while also holding a few active managers around the margins. But the more you mix and match different philosophies, the greater the risk that you'll abandon the one that's underperforming. Arriving at your investment philosophy and then constructing a portfolio that's a clean, uncluttered reflection of that philosophy sets you up to stay disciplined.

Put It in Writing
Once you've established your investment philosophy, it's a good idea to document it as well as the specifics of your strategy. Such documentation isn't guaranteed to keep you on the right track, but it can serve as a safeguard against upending your philosophy and, in turn, changing your strategy when it underperforms. My investment policy statement template gets right into the nitty-gritty of investment strategies, but you could also include a few bullet points at the outset to document your philosophy. For example, my overarching personal philosophy would be as follows:

  • Low-cost and tax-conscious
  • Concentrated
  • A strategic, hands-off approach to asset allocation and ongoing monitoring
  • A mix of active and index funds

Find Your People
Another way to ensure that you don't stray from your philosophy, and in turn your strategy, is to find a community of like-minded individuals with whom you can share information. The Bogleheads online community, both on and on the Bogleheads website, is the ultimate example. Index enthusiasts regularly swap portfolio-planning and other financial-management tips, and they also coach each other to stay on the right track. There are even two Bogleheads books and an annual Bogleheads conference.

Even if there's not an entire community devoted to your particular investment philosophy, you can still identify coaches to help keep you on the right track. Of course, this is one of the key roles that an investment advisor can serve. But you can also find like-minded investors by joining an investment club or participating in your local chapter of the American Association of Individual Investors. It also helps to identify columnists and authors who share your investment sensibilities; for years, The Wall Street Journal columnist Jason Zweig has been my personal must-read, providing a weekly blast of investment sanity.

At the same time, remember that it's possible to go too far in this direction, creating an echo chamber by seeking out information only if it corroborates what you already believe. Doing so can leave you vulnerable to the pitfall that behavioral-finance experts call confirmation bias. You shouldn't want your investment philosophy to change with the wind, but nor do you want to shut yourself off to new information simply because it runs counter to your beliefs.

See More Articles by Christine Benz

Christine Benz does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.