Investing: Models & Theories
- personal995
- May 19, 2024
- 12 min read
Updated: Dec 5, 2024
Index
Introduction
Models & Theories are essential tools for understanding, exploring, and interacting with the world around us. They help us unlock the mysteries of nature, solve practical problems, and drive progress and innovation in various fields of human endeavor.
With that in mind, first we want to align this with what we are trying to achieve. Ultimately we want to grow and achieve our Goals. The Models & Theories then, need to help us to formulate strategic plans that can do just so.
The thing with strategic plans is they are more often than not dealing with systems of chaos (human nature, environments, economies, complex adaptive systems etc), and as such can not be completely fixed. They need to be adaptable.
Dwight D. Eisenhower, the American military officer and statesman, once said, "In preparing for battle I have always found that plans are useless, but planning is indispensable."
There are very few perfect models or theories that suit every situation. Every individual's unique goals have specific requirements to successfully execute them.
However, there are often general, timeless, adaptable or customisable Models & Theories that can be utilised to begin building momentum, or which are suitable to create from, a unique and flexible strategic plan.
These Models & Theories are selected and continually curated with this aim in mind.
Get creative. Use the Models & Theories verbatim, if they serve you in that form. If not, use them purely as idea generators, as partials to build upon or as starting points to adapt and customise.
If none specifically suit, move on to the Self Review, Lessons and Case Studies and create your own working model.
Process
With your Values and Goals front of mind, what is it you are aiming to do or achieve? Once you have that clear for yourself:
Review all the Models & Theories below. Do any appear to provide the beginnings of a structure you can use as a strategic plan?
If so, start working through the steps and build momentum, adapting as it suits for your specific situation.
If not, do some partial aspects or a sum of parts approach to help you customise a strategic plan?
If still not, move on to the Self Review, Lessons and Case Studies and create your own working model.
Models & Theories
1. On Asset Allocation
Summary: The asset allocation process involves determining the optimal mix of asset classes (such as stocks, bonds, real estate, and cash) in an investment portfolio based on individual goals, risk tolerance, and time horizon.
Here's an overview of the steps in the asset allocation process and how it can assist someone in living well and doing their best work:
Set Goals: Define your financial objectives, considering short and medium term needs and long-term aspirations such as retirement, education funding, or entrepreneurship ventures.
Assess Risk Tolerance: Evaluate your willingness and ability to tolerate investment risk, taking into account factors like income stability, time horizon, and emotional comfort with market fluctuations.
Understand Asset Classes: Gain a comprehensive understanding of various asset classes, including stocks, bonds, real estate, and alternative investments. Recognize the distinctions between passive investing (e.g., index funds, ETFs) and active investing (e.g., individual stock picking or real estate).
Focus on Strengths and Competitive Advantages: Direct your investments toward asset classes and strategies that align with your expertise and competitive advantages. Whether it's thorough industry knowledge, a knack for analyzing financial statements, renovation knowledge, or a talent for spotting market trends, leverage your strengths to make informed investment decisions.
Allocate Assets: Allocate your investment capital across chosen asset classes in a manner that reflects your goals, risk tolerance, and strengths. Strive to create a diversified portfolio that capitalizes on your strengths while mitigating risks.
Consider Tax Implications: Factor in the tax implications of your investment choices, aiming to minimize tax liabilities and maximize after-tax returns. Utilize tax-advantaged accounts and tax-efficient investment strategies where applicable.
Monitor and Adjust: Continuously monitor your investments and assess their performance relative to your goals and expectations. Stay informed about market developments and changes in your personal circumstances. While asset rebalancing is removed, make adjustments to your portfolio as needed to stay aligned with your evolving objectives and strengths.
Conclusion: By focusing on asset classes and investment strategies that leverage your strengths and competitive advantages, you can build a portfolio that not only supports your financial goals but also enhances your sense of fulfillment and achievement. This tailored approach to asset allocation empowers you to invest in areas where you have confidence and expertise, potentially leading to greater success in both your personal and professional endeavors.
2. On Passive vs. Active Investing
Summary: Passive investing involves buying and holding a diversified portfolio with low fees, often through index funds or exchange-traded funds (ETFs). Active investing, on the other hand, involves more frequent buying and selling in an attempt to outperform the market. Understanding the pros and cons of each approach is crucial for investment success.
Here's an overview of passive vs. active investing and how each approach can assist individuals in living well and doing their best work:
Passive Investing
Overview: Passive investing involves buying and holding a diversified portfolio of assets, typically through low-cost index funds or exchange-traded funds (ETFs). The goal is to match the performance of a broad market index rather than attempt to beat it.
Steps:
a. Research: Identify broad market index funds or ETFs that track major indices like the S&P 500, total stock market, or global equity markets.
b. Allocate: Determine your asset allocation based on your risk tolerance, financial goals, and time horizon.
c. Invest: Purchase the selected index funds or ETFs and hold them for the long term, periodically rebalancing as needed.
d. Reinvest Dividends: Automatically reinvest dividends and distributions received from your index funds or ETFs back into the same investments to take advantage of compound growth over time.
e. Continually Invest Savings Over Time: Regularly invest additional savings into your portfolio, employing dollar-cost averaging by purchasing more shares when prices are low and fewer shares when prices are high, which can help smooth out market volatility.
Suitability:
Passive investing is suitable for individuals who prefer a hands-off approach to investing and have limited time, resources, or knowledge to actively manage their portfolios.
It's ideal for those who believe in the efficient market hypothesis and are content with earning market returns without trying to outperform the market.
Passive investing can also be suitable for busy professionals who want to focus their time and energy on their careers or other pursuits rather than active portfolio management.
Active Investing
Overview: Active investing involves actively buying, holding and selling securities with the goal of outperforming the market or achieving specific investment objectives. This approach often requires more time, effort, and expertise than passive investing.
Steps:
a. Research: Conduct thorough research and analysis to identify undervalued stocks, bonds, or other securities with the potential for above-average returns.
b. Make Decisions: Actively make investment decisions based on your analysis, adjusting your portfolio as market conditions and opportunities change.
c. Monitor: Continuously monitor your investments and market trends, staying informed about developments that may impact your portfolio.
d. Reinvest Earnings: Decide whether to reinvest earnings, such as dividends, back into the same securities or allocate them to new investment opportunities based on your investment strategy.
e. Continually Invest Savings Over Time: Regularly invest additional savings into your portfolio, seeking out new investment opportunities or adjusting your holdings based on changing market conditions and investment objectives.
Suitability:
Active investing may be suitable for individuals who have the time, resources, and expertise to conduct detailed research and analysis.
It's often preferred by investors who believe they can outperform the market through skillful stock picking, market timing, or other active strategies.
Active investing may also appeal to individuals who enjoy the challenge and intellectual stimulation of analyzing investments and making strategic decisions.
Conclusion: In summary, both passive and active investing strategies can benefit from reinvesting dividends and continually investing savings over time. Passive investing emphasizes dollar-cost averaging to smooth out market volatility, while active investing involves actively managing investments based on research and analysis. Ultimately, the choice between passive and active investing depends on individual preferences, goals, and circumstances.
3. On Cash Management
Summary: Cash management represents a strategic approach to liquidity management that balances the benefits of holding cash with the risks of inflation and missed investment opportunities. This approach emphasizes the importance of maintaining sufficient liquidity to meet short-term financial needs while also seeking opportunities to deploy cash strategically to capitalize on market downturns and undervalued assets. By integrating insights from economic theory and practical financial planning, individuals can optimize their cash holdings to preserve purchasing power, seize investment opportunities, and achieve their financial goals in both stable and volatile market conditions.
Here's a brief overview of these fundamentals and the steps involved:
Cash Management
Overview: Cash management involves strategically allocating funds to cash and cash equivalents, such as savings accounts, money market funds, and short-term Treasury securities, to meet short-term liquidity needs and capitalize on investment opportunities. It requires balancing the benefits of holding cash for emergencies and opportunistic investing with the risks of inflation and missed market opportunities.
Steps:
a. Assess Short-Term Needs: Evaluate your short-term financial needs and obligations, including living expenses, debt payments, and emergency funds. Determine an appropriate level of cash reserves to cover these expenses, typically equivalent to six to twelve months or more of living expenses, depending on individual circumstances.
b. Evaluate Investment Opportunities: Monitor market conditions and assess potential investment opportunities, particularly during market downturns or periods of volatility. Keep an eye out for undervalued assets or sectors that may present attractive buying opportunities.
c. Maintain Liquidity: Maintain sufficient liquidity to meet short-term financial needs and take advantage of investment opportunities as they arise. Keep a portion of your portfolio in cash or cash equivalents to provide flexibility and stability during periods of market uncertainty.
d. Mitigate Inflation Risk: Be mindful of the risk of inflation eroding the purchasing power of cash over time. Consider allocating a portion of your portfolio to inflation-protected securities or investments with the potential for long-term growth to preserve wealth and offset the effects of inflation.
Suitability:
Cash management may be suitable for individuals seeking to balance short-term liquidity needs with long-term investment objectives.
It's ideal for those who value flexibility and stability in their financial planning and want to maintain a cushion of cash reserves for emergencies or opportunistic investing.
Cash management can also appeal to individuals who are cautious about market volatility and prefer to have liquidity readily available to take advantage of market downturns or unexpected expenses.
Conclusion: In summary, cash management offers individuals the flexibility to meet short-term financial needs, capitalize on investment opportunities, and preserve purchasing power in the face of inflation. By strategically allocating funds to cash and cash equivalents while remaining vigilant to market opportunities and economic risks, individuals can optimize their cash holdings to support their financial goals and navigate both stable and uncertain market conditions effectively.
4. On Low Cost Index Funds
Summary: Low-cost index fund investing, influenced by the principles of long-term value creation and simplicity, represents a strategic approach to wealth accumulation that centers on passive investing in diversified portfolios tracking market indices. This approach, championed by renowned investors, emphasizes minimizing fees, reducing turnover, and harnessing the power of compounding to achieve attractive long-term returns. By integrating insights from investment pioneers and financial experts, index fund investors seek to build diversified portfolios of low-cost funds capable of capturing broad market returns while minimizing expenses and maximizing after-tax returns. This approach appeals to individuals seeking a hands-off, low-maintenance investment strategy aligned with their long-term financial goals and aspirations.
Here's a brief overview of these fundamentals and the steps involved:
Low-Cost Index Fund Investing
Overview: Low-cost index fund investing involves investing in passively managed funds that track market indices, such as the S&P 500, total stock market, or global equity markets.
Steps:
a. Research: Identify low-cost index funds that track major market indices and offer broad exposure to various asset classes, sectors, and geographic regions.
b. Assess Risk: Evaluate the risk-return profile of each index fund, considering factors such as historical performance, expense ratios, and tracking error. Focus on funds with low fees, minimal tracking error, and broad diversification.
c. Buy and Hold: Purchase shares of low-cost index funds and hold them for the long term, avoiding frequent trading or attempts to time the market. Embrace a buy-and-hold strategy to capture the long-term growth potential of the markets.
d. Monitor and Rebalance: Periodically review your index fund holdings and rebalance as needed to maintain your target asset allocation. Reinvest dividends and contributions to ensure your portfolio remains aligned with your investment objectives.
Suitability:
Low-cost index fund investing is suitable for individuals seeking a simple, low-maintenance investment strategy that captures broad market returns.
It's ideal for those who prioritize minimizing fees, reducing turnover, and harnessing the power of compounding to achieve attractive long-term returns.
Low-cost index fund investing can also appeal to individuals who prefer a hands-off approach to investing or lack the time, expertise, or inclination for active portfolio management.
Conclusion: In summary, low-cost index fund investing offers a straightforward, cost-effective approach to wealth accumulation that leverages the efficiency of the markets and the power of compounding. By focusing on low-cost, diversified index funds and maintaining a long-term perspective, investors can build wealth steadily over time and achieve their financial goals with simplicity and confidence.
5. On Value Investing
Summary: Value investing, influenced by the collective wisdom of investment luminaries Benjamin Graham, Warren Buffett, and Charlie Munger, represents a disciplined approach to wealth accumulation that prioritizes the identification of undervalued assets, particularly very high-quality businesses, trading below their intrinsic value. By integrating insights from Graham's focus on intrinsic value and margin of safety, Buffett's emphasis on durable competitive advantages and long-term holding, and Munger's emphasis on high-quality businesses with enduring competitive positions, value investors seek to build resilient portfolios capable of weathering market fluctuations while delivering sustainable long-term returns. This approach, rooted in fundamental analysis and patient decision-making, appeals to individuals who prioritize capital preservation, value long-term growth, and seek to align their investments with their broader financial goals and personal values.
Here's a brief overview of these fundamentals and the steps involved:
Overview: Value investing, influenced by the teachings of Benjamin Graham, Warren Buffett, and Charlie Munger, emphasizes identifying and investing in very high-quality businesses that are trading below their intrinsic value. This approach involves focusing on companies with strong competitive advantages, excellent management teams, and sustainable business models.
Steps:
a. Research: Conduct thorough fundamental analysis to identify businesses with durable competitive advantages, consistent earnings growth, and favorable long-term prospects. Look for companies with strong brand recognition, pricing power, and innovative products or services.
b. Assess Quality: Evaluate the quality of each business based on factors such as its economic moat, financial stability, and track record of delivering shareholder value. Focus on businesses with sustainable competitive advantages and resilient earnings power.
c. Buy and Hold: Purchase shares of high-quality businesses when they are trading at a discount to their intrinsic value, and hold them for the long term. Avoid excessive trading or trying to time the market, instead focusing on the long-term growth potential of the companies in your portfolio.
d. Monitor and Adjust: Continuously monitor the performance of your investments and reassess the quality and intrinsic value of the businesses in your portfolio. Adjust your holdings as needed based on changes in company fundamentals, market conditions, or your own investment objectives.
Suitability:
Value investing is an Active investing style and is only suitable for individuals who have the time, resources, temperment and expertise to conduct detailed research and analysis.
Value investing, shaped by the insights of Graham, Buffett, and Munger, is suitable for individuals who prioritize long-term wealth accumulation and are willing to invest in high-quality businesses with strong competitive advantages.
It's ideal for those who value capital preservation and seek to minimize downside risk by investing in businesses with resilient earnings power and enduring competitive positions.
This approach aligns well with individuals who have a patient and disciplined investment approach and are focused on building wealth over the long term.
Conclusion: In summary, value investing with insights from Graham, Buffett, and Munger offers a disciplined approach to investing that prioritizes long-term wealth accumulation and capital preservation. By focusing on businesses with durable competitive advantages and holding them for the long term, individuals can build a portfolio of resilient investments that support their financial goals and enable them to live well and do their best work.
6. On Real Estate
Summary: Real estate investing represents a strategic approach to wealth accumulation that centers on identifying and acquiring properties with strong intrinsic value and income-generating potential. This approach emphasizes thorough market research, property evaluation, and risk assessment to identify opportunities for cashflow, value creation and long-term appreciation. By integrating insights from industry pioneers and experienced practitioners, real estate investors seek to build diversified portfolios of high-quality properties capable of generating passive income, capital appreciation, and lasting financial stability. This approach appeals to individuals seeking to leverage the tangible assets and income streams offered by real estate to achieve their financial goals, secure their futures, and pursue fulfilling personal and professional endeavors.
Here's a brief overview of these fundamentals and the steps involved:
Real Estate Investing
Overview: Real estate investing involves purchasing, owning, and managing properties with the goal of generating rental income, appreciation, or both. It offers various investment strategies, including rental properties, fix-and-flip projects, and real estate investment trusts (REITs).
Steps:
a. Research: Conduct market research to identify promising real estate markets and investment opportunities. Analyze factors such as population growth, job markets, rental demand, and property prices.
b. Assess Risk: Evaluate the risks associated with each real estate investment, including property-specific risks (e.g., maintenance costs, vacancy rates) and market risks (e.g., economic downturns, regulatory changes).
c. Buy at a Discount: Look for undervalued properties or distressed assets that can be purchased at a discount to their intrinsic value. Negotiate favorable purchase terms and seek opportunities to add value through renovations or improvements.
d. Monitor and Adjust: Continuously monitor your real estate investments, including rental income, expenses, and property values. Adjust your investment strategy as needed based on changes in market conditions, rental demand, or your own financial goals.
Suitability:
Real estate investing may be suitable for individuals seeking diversification beyond traditional asset classes like stocks and bonds.
It's ideal for those who value tangible assets and the potential for generating passive income through rental properties or REITs.
Real estate investing can also appeal to individuals with expertise in property management, construction, or real estate development, as well as those who enjoy hands-on involvement in managing their investments.
Conclusion: In summary, real estate investing offers opportunities to generate long-term wealth, passive income, and financial stability. By following a strategic approach to property selection, risk management, and portfolio diversification, individuals can leverage the unique benefits of real estate to achieve their financial goals and create a foundation for a fulfilling life and successful endeavors.
By reviewing these models and theories above you can pick and choose what may work best for you and your own unique situation, try, test and refine your process to suit. To the point where you begin to see improvements and compound your results moving forward.
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