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Investing is all about decision making so I thought it’d be a good idea to explain how I generally decide what to invest in.
1 Choosing a Theme
Only two things in life are for certain.. well maybe three: death, taxes and the passage of time. The decision to align my personal investing activities with specific themes is directly linked to the passage of time. As the world spins, one of the only certainties is that the sun will rise, form a loop, then set. Given the systems that govern how we operate as a species are capitalistic ones (including how wealth is built), whether I choose to participate is not the question. Rather “how”, is what I spend time trying to figure out. I like to align with themes i.e. observable trends because by definition of time, they have to play out and time will judge the outcome. The speed, accuracy and substance of a theme can all be debated as things unfold. Investing is simply a way to align with the world around me.
So in that vein, my first point of call in my personal investing decision making process is to define a theme which I believe to be an observable trend - I may have come across it through lived experience or secondary research. For example: population change is something I explored quite deeply during university from an array of lenses and became quite interested in. Overlaying my investing lenses in regards to this theme, I thought about the following:
Conceptual Understanding of the Topic
Geographical Biases
What Does Consensus Say?
Winners & Losers
Protagonists & Antagonists
2 Methods of Expression
Once I have a strong grasp of a theme, or at least deep enough to understand the state of play and potential paths of change, I search for a method of expression. Keeping in line with the population change example, geographical biases pointed me in the direction of seeking exposure to healthcare and emerging markets. Large parts of developed europe are experiencing an ageing population while places like Japan struggle with a declining birth rate. With that said, healthcare advancements are keeping people alive for longer and in doing so, the big pharmaceutical/tech infused companies continue to monopolise and drive technological advancements. I have some healthcare innovation exposure to reflect this.
On the other hand, places like India have a burgeoning population with an ever-maturing middle class, younger labour force in comparison to many western countries and a path to further economic prosperity/power. Of course things are not perfect and many issues pose real threats but nevertheless, it is a trend that has been in play for some time which is attractive for me to align with. I have some India and China broad market exposure to reflect this.
3 Holding Period
Once I find an instrument which expresses my view about a certain theme, I then determine how long I would be willing to ride the wave (hopefully higher and not lower). This is mainly determined by the nature of the theme. Is this something that will evolve over the short term i.e. within six months to one year. Something like population change arguably occurs over decades but the implications and dynamics shift more visibly in the short to medium term so I am comfortable with setting a holding period less long term oriented.
4 Catalysts
This part is easy but hard at the same time. I ask myself:
What Makes This Investment a Good Decision?
What Must Happen for the Theme to Play Out?
Is There a Single Event or Chain of Events Required?
Once I have outlined catalysts, I assess where I am on the trend timeline before deciding whether and how to pull the trigger - I explain more during part 2 of this publication. Nevertheless, this allows me to be super reactive to the world around me because I could be patiently waiting for a specific scenario to happen which may come as a complete surprise to other people who are not engaged.
5 Risk Parameters
This is very much in line with the catalysts discussion - instead, risk points towards the negative side of the coin. Every investment poses inherent risk which can be defined in numerous ways as well as measured and managed differently. Taking a simple approach and considering my personal circumstances, I use the below framework to assess the overall risk of my individual investments as well as the impact on my broader portfolio.
To be clear, my ETF portfolio is separate to my pension, passive pot and all else - existing with the sole purpose of being aggressive. Therefore, I take more risk with it compared to other activities.
Base Case
This is the outcome which I expect to be the most likely. In order to substantiate this, I usually do some research to try and establish the consensus view.
Then I attach the % change in the value of the investment I should probably expect if the base case outcome were to play out. For instance this could be +5% or -5%.
Best Case
This is the outcome which I expect to be a positive surprise if it were to occur. As with the base case, this is usually informed by my own research and due diligence generally demonstrating more optimism than the consensus.
Similarly, I attach the % change in the value of the investment I should probably expect if this outcome were to play out.
Worst Case
This is the outcome which I expect to be a negative surprise if it were to occur. Again, I attach the % change in the value of the investment I should probably expect if this outcome were to play out.
Summary
The point of this exercise is not to make perfect decisions, because if I could see the future I’d already be a millionaire by now. Instead, it provides a solid framework for me to approach my risk and refer to when things get volatile. For instance, if I know that the combined losses across my portfolio as determined by my worst case scenarios is £5000 then I need to ask myself whether I am comfortable with that or not and if so, under which circumstances. A solid framework helps me stay cool.
Following on, it allows me to assess the present time and inform my decisions. Right now, some parts of my portfolio are definitely in the best case realm so I am not adding to those positions without further assessment. Conversely, I am happy to add more freely to parts which are less exuberant. so long as the theme and catalysts are in check.
Look out for part 2 of this publication where I will discuss:
6) Exit Plan 7) Sizing 8) Correlations 9) Timing 10) ETF Profile
Catch you later.
Peace!