⚠️This is one of my longer blogs to help show how the investment strategy is formed in stages. Grab a coffee and buckle up.

An investment strategy is a plan that helps investors allocate their financial resources in a well-thought-out and written-down manner to achieve their financial goals. It summarizes what you invest in after creating your investment philosophy, which outlines your reasons for investing. The investment strategy serves as a roadmap towards making informed investment decisions that drive your investment process, which is essentially how you invest.

TABLE OF CONTENTS:

What is an Investment Strategy?

You’ve gone over the Investment Philosophy component. You’ve outlined your core beliefs around markets, why you want to invest and the styles you align with. Now what do you do with all this information?

You need to develop it into an actionable plan that forms your investment strategy. This part will have some crossover from the Investment Philosophy Guide. Why you invest is now going to be channelled into, what you invest in. These two are interconnected and will drive your investment process and how you invest according to your strategy and plan.

When building your investment strategy there will be several factors to consider. All of these have been discussed in the Philosophy questionnaire. Such as risk profile, financial goals, time horizon, asset allocation, and the investment style you gravitate towards.

You need a strategy, and a trade and investment decision can only be evaluated in the context of that strategy.

Aaron Brown

The investment strategy will determine how hands-on you want to be (or need to be).

To make the plan successful you need to stick to it. It is your “Business Plan” on how you will conduct your investing affairs. The strategy can help you reach your financial goals. You need to adopt the right approach that compliments your investing style and aligns with your philosophy. All of this can create a much more efficient investment process.

The key to achieving any financial goal is to determine the required return percentage associated with it. Once you have identified your starting amount and goal, you can determine the types of assets or risk levels required to achieve it. This is just one of several factors to consider when developing an investment strategy, as we discussed in the philosophy section.

Why do you need an Investment Strategy?

You need a guide to making investment decisions. If you have no strategy, you may invest based on emotions, and short-term thinking, with no objective. You cannot give direction to the investment process. A lot of the time investors change investors styles, speculate, chase what’s hot and succumb to “Herd Mentality” or Greed and Fear.

When you have a plan, a detailed well-thought-out plan that is written down, you become focused. That becomes your guide, the way to navigate a universe far too big to “Wing it”. The plan and strategy do not mean never being flexible, or adapting as you evolve. It simply gives you a North Star to follow so you can stay the course.

Stick to your investment strategy…

Warren Buffett

No matter how far along the investing journey you are, having an investment strategy can help you reach your financial objectives. The strategy will only work if it is implemented. It can be complex to start with, that’s why financial advisors can charge $2,000 – $5,000 to help draft one. However, if you go through all the areas in the philosophy section it will help you form your plan. You must get started now, there is no such thing as waiting for the right time or the right amount of money.

The strategy needs to be actionable. That is why the details matter, the goals matter, and the risk and time frame matter. Your Philosophy needs to be actionable, not unrealistic with over-ambitious goals and overconfidence bias about your ability to invest.

Take the time to think about what you want to accomplish and write down that goal. Then outline what you need to do to achieve it. This plan means you know what you are aiming at and have an idea of how to get there.

The financial Goals and objectives are the cornerstone.

The strategy can only be fruitful if it can present the right action plan to achieve your long-term goals. Setting clear financial goals is an important step in developing the investment strategy. For a lot of investors, these goals will change over time especially if you want to invest full time. Having a goal to buy a home and retire early will have a different goal set for someone who has created a decent base of wealth and wants to then pursue investing full-time.

The goal may then become to achieve a certain % return every year and the goal then becomes a little less unrelated to a destination. For me, my goal is to compound capital and continue to accelerate my net worth. That is the goal. I don’t have a number in mind. Continue investing long-term, don’t do anything stupid and ensure for all the effort I achieve double-digit % returns annually. Otherwise just index.

However, for most investors, they need a certain goal. A clear precise or SMART (Specific, measurable, achievable, relevant, and time-bound) Goal. This will provide a sense of purpose and direction which is the foundation of your investing decisions. The goals can vary, it is best to have a couple perhaps shorter term and longer term. If the goals are less than a few years, then the stock market is not an ideal place to park capital, unless you know what you are doing.

By setting clear goals, the plan has a clear target and becomes time-bound, which gives the investment process something to focus on.

Some hypothetical goals to understand what I mean.

If you have a financial goal, it’s essential to approach it logically and create a plan to achieve it. To do this, you need to work backwards and calculate the types of returns you would need to make annually to achieve that goal.

For example, if you want to create a $1 million investment portfolio by the time, you’re 45 and you’re 35 now, you have $100,000 to start with. To achieve your goal, you would need to make at least a 25% CAGR on your capital, which is not realistic for most investors.

Instead, you need to calculate the types of realistic returns you need to make annually and invest in asset classes that can deliver these returns without taking on a lot of risk.

If your goal is income-based, such as achieving a passive income of $50,000 annually, you can invest in bonds, dividend ETFs, or a collection of dividend aristocrats that average a yield of 5%. With a $1 million portfolio invested in income-producing assets, you can achieve your $50,000 income goal.

Similarly, if you want to save for a down payment on a home in 5 years and you need $150,000 and already have $100k, you then need to make an additional $50,000 in 5 years. Work backwards, and you will find that you require an 8.5% per annum return to achieve your goal. In this case, you can invest in a broad market index to achieve these types of returns without taking on a lot of risk.

Other factors needed to build the Investment strategy?

Age is another important consideration, as it affects your investment horizon. The younger you are, the more risk you can tolerate, as you have time to recover from losses and benefit from compounding. As you age, your focus should shift to preserving capital, rather than aggressively growing it. However, there is always a place for both offensive and defensive asset allocation, regardless of age.

Risk is inherent in every investment, and it is important to understand the relationship between risk and reward. When considering higher-risk opportunities, it is crucial to determine the level of risk that makes it acceptable. If you are risk-averse, you should ensure that your asset allocation is designed to accommodate your behaviour. Conversely, if you have a high tolerance for risk, you should still allocate some of your portfolio to defensive assets.

Your current financial situation and personal circumstances are also important factors to consider when developing an investment strategy. If you have no starting capital, you can begin by dollar-cost averaging and gradually building up your portfolio. If you have a lump sum to invest, you can start building your portfolio immediately.

In short, investment strategy requires careful planning and consideration of several factors, including income, financial obligations, goals, age, risk tolerance, and personal circumstances. By taking a holistic approach, you can develop a strategy that is tailored to your needs and objectives.

Where do you have an edge?

Your edge will help to further refine the strategy to give the process more direction. This blog focuses predominately on active investing. As such, the tips are geared towards this approach. Investing is a skill that can be developed like anything else. If you have the time to learn research and self-educate yourself, you will become a better investor. If you have the passion and curiosity to understand capitalism, the engines of economic growth, and studying companies and how they work, then you are better prepared to identify potential winners.

To define your edge which coincides with your circle of competence you need to look at the three areas below. We have previously touched on these areas but now it is time to outline where yours may lie, if anywhere. This will ground your strategy and weight it to your areas or strength to counter your areas of weakness.

Informational Edge:

Knowing more about an investment than anyone else. Everyone has access to the same information. You must be prepared to “scuttlebutt” and go beyond to find and research more than the average investor. Insider trading is an informational advantage, and illegal, which is why it is rare to gain an informational edge. It is still possible; by doing more than the usually informed investor. This can also be about how information is interpreted. You can still have two investors read the same annual report however interpreting it with second-level thinking is still an edge.

Analytical Edge:

Experienced investors and analysts use a variety of valuation and forecasting models. I don’t think many private investors including myself can conduct better analysis than highly paid professionals who run interactive models all day. They get paid to analyse not to invest. It is hard to create an edge in this way. You need to know where your analytical edge lies.

For example, from my entrepreneurial and business experiences I am better off valuing companies in the micro and small-cap segment. It is easier for me as these businesses have 1 or 2 business lines as opposed to mega caps with global entities and all sorts of revenue segments. I can also compare valuations like Enterprise value to the private equity market.

Behavioural Edge:

This is about your emotions, your behaviour, and your virtues around patience and discipline. Investing is not just an intellectual sport. It is about conducting yourself and staying composed for the long haul. Successful investing over a longer time horizon becomes more about psychology than anything else in my opinion. Providing structure in the process, checklists, thesis, and systems you can outperform a lot of average investors by bringing a behavioural edge to the mix.

Composure when your position drops and when others are fearful. Contrarian when everyone is selling, and you are swooping in. I believe my edge is mostly around behaviour. To maintain the plan no matter what is happening.

Implement the investment style you gravitate to.

Gravitating to an investment style can help further narrow down how you invest. Investors should not implement an investment style by the process of elimination. All styles work, to those who are committed to them. Rather an investor should align with the Philosophy behind a style, study it, research it and see how it can fit into your strategy.

It must align with everything. If you develop the belief that you can not beat the market and that passive investing in index funds and ETFs is the way to go, then that helps to narrow down the asset allocation strategy. If you think markets can be inefficient and believe identifying undervalued opportunities is something you can do, then that also narrows down what to look for.

Remember it’s not about the style, it’s about what can help you achieve your financial goals. If you are a passionate active investor with a higher risk appetite, you can actively develop a portfolio of high-growth stocks and still build a position over time in some long-term ETFs or quality mega caps.

It’s about finding the balance between what you align with and how it transfers into hitting goals. Investment styles can range from conservative to highly aggressive, passive to active, value, growth, you name it the list goes on. This is why in the Philosophy component we pushed you to think about your beliefs around markets and what makes sense to you so that the high-level strategy can be further refined to investment styles.

Determine your asset allocation.

Research has shown that the biggest factor affecting long-term investment returns is asset allocation. Asset allocation involves building an investment portfolio that takes into consideration the investor’s risk tolerance, time horizon, and desired returns to achieve their financial goals.

Once an investor has determined their goals and time horizon, they can calculate the expected returns they need to achieve those goals. This will help them focus their investment plan on specific areas. By having an idea of the required returns, they can tailor their asset allocation to achieve them.

To put it simply, if an investor only needs a 3-5% annual return to achieve their goal, they may not need to invest in stocks. If they need a return of 5-8%, they can invest in a combination of stocks, bonds, and other asset classes. If their goal requires them to generate a return of 8% or more, then their asset allocation strategy should focus on stocks. By understanding the expected returns, investors can have a clearer picture of their asset allocation.

Asset allocation refers to the distribution of an investment portfolio across different asset classes, such as stocks, ETFs, bonds, cash, and alternative investments. The key principle behind asset allocation is diversification, which aims to spread risk and enhance potential returns.

If an investor needs a higher return to meet their investment goal, then their asset allocation strategy should focus on the asset class that can generate that return, such as stocks. For example, if an investor has a goal of generating a 9% annual return over 10 years, investing all their money in a bond that yields 2.5% will not help them achieve their goal.

Identify the area of the market to focus on.

Further to asset allocation, comes investment selection criteria. Whether it is looking for individual companies or ETFs in specific industries you need to know where you want to “play”. As much detail as you can put into your strategy the better prepared the process becomes. There are thousands of companies, financial products, and securities to pick from.

Too much choice can create “Analysis Paralysis” overwhelming investors. Narrowing down the region, the industry and the market cap range can help to bring more light to the strategy. Defining the criteria creates a much more concentrated approach. The qualities of business and the fundamentals are very important criteria. This is where the style such as looking for quality, growth, income or undervalued opportunities comes in.

Based on your edge, your goals and all the other factors discussed, you may decide to focus on small caps in growth sectors for example. You also like the idea of the economic growth engine of the overall stock market. So, you may choose to identify some broad-based Index funds to do the heavy lifting over a long period. This then means you can actively focus on the segment where you believe you have an edge and can get a better return.

Different asset classes will have different criteria around them. Index investing may be defined by a theme, a region, or the type of benchmark you want to invest alongside. Individual securities can be defined around your competence, what you want to actively study, research and develop an edge in. Bonds have criteria around them, Junk bonds or low-risk Government bonds.

This takes time. Newer investors need to think about this. It is not a straightforward plan to align goals with the criteria selection.

When to change and evolve your portfolio?

Your strategy will serve you until you achieve your goals or as you evolve as an investor. My strategy will change from 100% stock and capital growth-focused, to capital preservation and income producing as I get older.

There are three factors to consider when looking at how your investment strategy will change over time. Rebalancing, your goals and circumstances evolving and Portfolio Management i.e. when to sell a stock and Thesis break.

We will explore in greater detail rebalancing when to sell a stock and thesis break in the Portfolio Management section of the website. In brief, rebalancing is exactly what it sounds like. You allocate capital in a portfolio towards your asset classes and stick to a strategy for example a 60% Stock and 40% bond split. Rebalancing occurs when there is an imbalance in the portfolio say to 80/20. So, you would then sell down your stock holdings to rebalance the bonds back to 40%.

Selling a stock due to thesis breaking means selling a stock when the story no longer aligns with why you brought the stock. This could be a stock failed to perform or live up to the growth. It could also be from a stock reaching its intrinsic value and you book profits. Having a thesis and reason for investing in any asset BEFORE you do it can help you to know when to exit it.

The final step is your circumstances changing. Perhaps you reached your goal. Maybe you are older and want to focus on income and not take as much risk. Sometimes your style changes and you get more confident so you prefer to become more active and take more risks the older and more experienced you get.

Two examples of Investment Strategies.

In a highly simplified explanation let’s run a hypothetical of two different investors. Both in a different age group with different goals, styles and focus.

STRATEGY	30 Years Old	60 Years Old
FINANCIAL GOAL:	To aggressively grow their capital and increase net worth.	To retire with a passive income to live at the beach with his wife.
FINANCIAL POSITION:	Not much capital but a high paying job with expendable monthly income.	Already created a nest egg and now wants to protect it and for it to provide income.
CIRCUMSTANCES:	Single	Married with grandkids
RISK PROFILE:	Aggressive	Conservative
TIME HORIZON:	Wants to retire by 50 so has a 20-year time horizon.	Retired already investing forever.
INVESTMENT STYLE:	Active approach likes growth stocks and quality.	Passive approach and aligns with dividend investing.
ASSET ALLOCATION:	100% Stock allocation. 50% in active individual stocks with high growth potential and 50% in thematic ETFs.	80% allocated to high-yielding bonds and 20% allocated to mega-cap dividend aristocrats.
PERSONAL EDGE:	Young, and energetic, works in the tech sector and understands the hyper-growth tech industry they invest in.	Patient, has seen markets go up and down, understands mature companies and the bond market.
MARKET FOCUS:	Small-caps, early-stage companies in emerging sectors.	Bond Market / Blue chip large caps.

Though this is a simple example you can begin to see how laying out the plan addressing each of the factors brings the strategy to life. The more detailed you go into your goals, your Why and what you want to invest in and allocate to you can shape a very detailed roadmap that is actionable. It does not have to be a 100 page plan, just a well-thought out one tailored to your needs and objectives.

A brief outline of my investment strategy.

I am investing to grow my capital and increase my net worth over the next 3 decades. The style I align with is GARP (growth at reasonable prices) and quality because I believe in investing in growing companies that have bright futures ahead, but I don’t want to overpay for built-in expectations.

I believe markets are mostly efficient at the top end however are inefficient in the micro-cap and small-cap sectors. So, I focus there on companies that align with in my circle of competence and experiences. I search around the world for the best in class not the best in one country.

My strategy runs two portfolios side by side. A passive ETF portfolio in a retirement fund. I dollar-cost into this because I believe in the long-term growth of the stock market and the economy.

My active fund where I spend all my time is very concentrated and focused on small caps in growing industries with the qualities I look for, such as profitability, high ROIC, strong gross margins, small share float, and non-dilutive etc… (There is more to it than this however this gives you an idea of the criteria).

As I get older, I may transition to an income-focused style to persevere capital if I am unable to put the work into actively picking stocks. I aim to generate double-digit returns every year. I sell when the thesis breaks, and I back my highest conviction ideas up to 20% of the portfolio and I don’t rebalance often if at all.

That is a general outline of my approach to help you understand what a mission statement can look like.

In Summary…

This is a long blog to read because I wanted to lay it out in steps and address each of the factors. Once an investor goes through each of these questions it is best to put it all into a mission statement as mentioned in the philosophy guide.

Always remember the goal is not to beat a benchmark, the goal is to achieve our financial objectives. That is where I see a lot of investors steer of course. No matter what you are trying to pull off like investing in sustainable opportunities or groundbreaking innovation there will be a strategy you align with to achieve your goals.

The most important takeaway from this is to define the over-ruling goal and objective then work backwards to re-engineer the expected returns required. So many investors miss this part. It can mean your taking on too much risk to meet a goal that could be achieved with other asset classes and strategies. Or you are too conservative to meet a much bigger goal and need to reallocate to higher risk/return investments.

Build your portfolio gradually and slowly expand your investments. Adjust your plan as your goals shift and as you become a better investor.

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