Good morning,
Today is this week’s free newsletter and the topic surrounds accountable investing.
So far this week we have discussed the following topics:
• Monday: Bears, Recessions and Corrections (Subscribers Only)
• Tuesday: Ratings Agencies and their Role in Financial Markets (Subscribers Only)
• Wednesday: Portfolio Update: Acquisition of Peloton Shares (Subscribers Only)
• Thursday: Apple’s New Fitness + (Subscribers Only)
• Today: The Importance of Accountable Investing (Free Newsletter)
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The Importance of Accountable Investing
Today i wanted to discuss a subject that i think every investor will benefit from, and that is accountable investing.
Accountable investing relates to the ability of oneself to have some method of holding your investments accountable to yourself or others. With this, comes a whole host of advantages that can only improve your investing over time.
This could be facilitated in many ways. For me, this means keeping a public account of my analysis, sharing my investing principles, sharing my investments with full transparency in buys and sells, detailing my rationale for every investment decision, sharing updates on my portfolio and discussing my ideas in public space with other investors.
I largely share my insights and ideas through my Twitter page. I also openly share my rationale, as well as my general investing goals for both of my portfolios. In my newsletter, i will typically go into much more granular detail to support my investment decisions.
This simple act of sharing my investments publicly adds a small step into the investment decision process.
You will see below a fairly rudimentary decision making process. The diagram illustrates an un-accountable investment decision. The idea is sparked, the analysis is conducted, a decision is made, and the investor will then proceed to buy/sell or do nothing.
The second diagram, is yet another rudimentary decision making process, but with a few extra steps involved. These extra steps, in my opinion, improve my investing vastly.
My process typically involves the formation of an investment idea, either by discussion or stock screening, which is then followed up by an informal analysis where i skim over the recent financials and annual/quarterly reports. If i like what i see, i will then conduct a deeper analysis. At this point, i will begin to physically draft a document where i share my insights and analysis of the company fundamentals. Prior to the creation of ‘Investment Talk’ i would document my analysis internally and save them on my computer. However, now with the creation of IT, I will then share this analysis with the readers of my newsletter. At this point, i am being held accountable to my readers. I am reminded of the investing strategy and goals i have shared, and must ensure that any investment decisions i make are appropriate with respect to those goals. If the company i am studying matches those goals, i will make a decision to buy.
This also relates to the act of selling a position. Without accountability, it can be easier to sell a position for reasons out-width your own rules. If you have not formulated some set of checklist items from which enables you to sell, then the rationale for selling will become weaker and may be costly down the line. You may catch yourself selling a position for no reason, perhaps simply out of frustration due to the unsatisfactory price movement of the stock.
Let us imagine you hold Stock A. The stock has advanced 3% in the one year that you have held it. You become bored and sell it for that reason only.
Quite often stocks can be fairly flat or unexciting for vast periods of time. A stock that has 0% returns for 9 years, and then advances 100% in year 10, will have a 20% compounded annual growth rate over 10 years. It helps to think of returns in this way.
For me, if i want to sell a position, i need to answer some questions first to test my rationale for selling, and seeing if this lines up to my conditions for selling that i previously set out.
I once had a conversation with a friend of mine about selling my position in Paypal, when the share price was around $135. The acquaintance asked me, ‘why do you want to sell?’. My response centered around the fact that the competition in the space is heating up and the fact that Paypal’s product was not being utilized across the same number of applications as some other competitors.
My acquaintance asked me a few questions:
Q: Has the fundamentals of the business severely worsened?
A: No. In fact, they were getting stronger and accelerating.
Q: Has the management quality eroded?
A: No.
Q: Do you have any superior locations for the capital right now?
A: No.
Q: Is the allocation size becoming too large a portion of your overall portfolio?
A: No. At the time, the position was only 5/6% weighted.
Q: Is the original thesis for investing in Paypal broken?
A: No. It was still very much in tact.
He then shared with me this diagram.
The conclusion was that i had no rational reason for selling my position. None of my pre-established red flags that would warrant a sale, were triggered. I was being irrational and allowing whimsical, trivial thoughts to occupy my mind and blur my vision. I decided not to sell, and have since been handsomely reward for holding.
Holding a stock after it has advanced 100% or so, is a difficult mental task for an investor. Depending on your style, one needs to be able to appraise a stock with zero bias, regardless of how much return has been generated for the position thus far.
If i had not re-assessed my selling checklist, i would likely have sold my position, and missed out on the additional 40% or so gains from the point where i considered selling.
Accountable investing is not just about being accountable to the others, it is most important to be accountable to yourself. You need to have processes in place to allow you to pause and really dissect your thought process.
As a retail investor, it can be difficult to hold yourself accountable. After all, the only person you are answering to, is yourself. So here are a few methods that can assist you in this plight:
Effective Methods of Accountability:
Here are a few methods that you can adopt to help usher in the accountable investing.
1) Keeping a Personal Investment Journal:
- I think this is perhaps the easiest and most effective method of accountability. Dependent on your investing style, if you are buying individual equities, you will likely make a significant number of transactions over the course of one year.
You may only be buying, or you may be buying and selling. Each time you make an investing decision, it is assumed that some level of thought, analysis and rational would have been utilized in order to come to a decision. I personally, would find it difficult to remember precisely all of the factors that led to those decisions.
Keeping a journal will provide you with an archive of every investment decision you make, the rational for the decision at that time, the logistics of the trade, and the analysis conducted. This will allow you to revisit decisions and examine your thought process at the time, evaluating both successful and unsuccessful investment decisions.
Say you sold company X at $25, and one year later the company was trading for $60. You would benefit from going back to your archive, and re-evaluating why you sold that position.
In order to maintain a useful journal, it helps to include a detailed analysis of the company and their earnings, the rational for the buy/sell, the reasons why the company fits your investing goals, and your own commentary.
One huge advantage of a journal, i have found, is that it helps prevent rash decisions. For me, , i force myself to conduct a full write-up of the company and my rational before making a trade. This way, i have to put the work in first to fully understand the value proposition, and evaluate my own logic for buying or selling. This prevents me from the ‘buy now, analyse later’ mindset, which can prove costly.
2) Draft an Investment Policy Statement:
An investment policy statement is typically a document drawn up between a fiduciary and a client and lays out the needs and wants of the client in terms of their financial goals, willingness to take risk, ability to take risk, asset preferences, time horizon, and so on.
For yourself, this does not have to be such a formal document, or even a document at all. But i think it is really helpful to have some form of documentation that lays out your investing goals. This way, you will know exactly what you want to achieve and how you want to achieve it. It also helps you from deviating from your pre-set goals and tolerances.
Some of the items in your IPS can include:
- Your investing strategy. Are you an investor concerned with fundamentals, or more of a technical analyst, concerned with price action.
- Your asset exposure. Do you want to be 100% equities? Or would you rather balance your portfolio across multiple asset classes, such as fixed income, equity, derivatives and real estate.
- Your time horizon. What length of time do you plan to hold the majority of your portfolio holdings? If you are a young, long term investor, your time horizon may span several decades, meaning you have more time to allow for volatility and potential losses. Thus, your risk tolerance may be somewhat higher.
- Your risk tolerance. Are you more inclined to be conservative in your investing approach? If you are conservative, your objective may be to match the benchmark, or simply minimize losses in the event of financial downturns. This may include holding a basket of equities, bonds, gold and so on. Conversely, you may be more attracted to higher returns by selecting individual equities, and are happy to take on greater implied risk.
- Portfolio weightings. This can span across multiple aspects. You may wish for a 40/60 split from bonds and equities. You may be 100% equities, but decide that the limit for an individual holding is 10% of your portfolio. You may want to split your equity holdings between value and growth positions. For me personally, i typically hold around 50% in income producing positions, 35% in growth, and the latter in value or special situations. The returns may be lower during some periods. but equally my losses may be minimized relative to holding 100% value, or growth.
- Your ability and willingness to take risk. The willingness to take risk relates to how risk adverse you may be, whereas the ability to take risk relates more to your personal financial situation. For instance, you may earn $5,000 per month, and have fixed outgoings of $3,500 per month. Another person may earn $4,000 per month but only have fixed outgoings of $1,500 per month. The second person, despite earning less, has more ability to take risk in that 62.5% of their income is disposable, whereas the first person only has 30% of their income being disposable income.
- Your benchmark. What are your expected returns? Do you want to simply match or beat the benchmark of your choice? Also selecting an appropriate benchmark is important. If you hold 40% bonds and 60% large cap dividend stocks, then using the Nasdaq (primarily made-up of US tech companies) is a poor choice of benchmark as it does not reflect similarity to your own holdings. Equally, if you hold a 50/50 split of US and foreign equities, a US benchmark may not be appropriate either.
These are all considerations you can and should make in order to better understand and facilitate your long term investing goals.
3) Tracking Metrics
Tracking the metrics of your chosen companies is a useful tool. Let us say that you buy some Starbucks on June 11th at $71 per share, and at the time the PE is 17, the PS is 4 and the P/FCF is 2 (all made up figures). Make a point of documenting these figures, so that when you come to perhaps buy additional shares, you can compare this to your previous purchase and see if you are getting a cheaper or more expensive valuation.
4) Scorecards
Scorecards are a powerful source of determining if a company is right for you, based on your own desired metrics. Brian Feroldi, from the Motley Fool, has an insane excel spreadsheet where he assigns companies a rating from 0-100 based on items such as; growing revenues, growing TAM, gross margins, management, free cash flow positive, moat, and a whole host of other metrics. Starting at 100, Brian removes points for any areas where he feels the firm lacks full marks.
You can find Brian’s scorecard on his Twitter page. I am personally going to create a similar scorecard in the future, out of inspiration from Brian’s model. It is a really superb idea, but may be time consuming to create a personalized one. At the end of the day, you get out, what you put in.
5) Public Journal
A public journal has all the benefits of a personal journal, but with the added accountability of sharing your ideas with others, and being open to criticism. As you know, i document my entire investing analysis and decisions all here in my newsletter. The two primary reasons are to help educate newer investors with transparency, and secondly to improve my accountability. This is a learning tool for me also. With the rise of self-publishing via platforms like Gumroad, Twitter and Substack, you can anonymously share your journey and receive some useful insight and feedback from observers.
6) Decide when to sell
We touched on this before, but i really find it useful to have a pre-defined set of circumstances that you can rely upon when it comes to selling. For all the reasons discussed previously, this can help you avoid making rash and irrational decisions.
These were just six methods that i have personally found useful, but if you have any more please feel free to comment down below.
Benefits to Accountable Investing:
Below i have compiled some of the benefits from increasing your accountability in terms of your investing.
• Ability to learn from past mistakes
• Prevention from making repeated mistakes
• Allows for time to reflect on decisions, prior to making them
• Prevention from making rash decisions
• Curation of an archive of prior insights, analysis and rationale
• An educational tool for your own investing progression
• If sharing publicly, it allows for you to hear the other side to your arguments, and challenge your ideas.
• After a long period of time composing and writing your analysis, it will gradually improve your analytical ability.
Negatives to Accountable Investing:
• This may add pressure to your investing, in terms of time consumption, or publicity.
• You may become so enthralled with your pre-defined rules that you forget to challenge your own thinking and step outside of your comfort zone
• This may lead to over analysis
Overall, i think that adding some accountability to your investing approach will yield some great results in terms of returns and your own self-development. The time consumption aspect may be a large red flag for retail investors, who most often do not have the time to study individual equities in great detail anyway. I am fortunate in that my work allows me to have copious amounts of free time to do so. However, the input will be rewarded in that it will make you a more competent and confidence investor.
That wraps up today’s opinion piece, i hope that was enjoyable, and i hope you all have a great weekend.
See you next week
IT