Revisiting Investment Philosophy

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The Great Recession in 2009 was the largest market downturn the stock market experienced since the Great Depression in 1929. Since then, we’ve had 10 relatively consistent years of strong market performance to make up for the losses incurred in 2009 and take us to new market highs. On Thanksgiving week, the Dow Jones Industrial Average, one of the most commonly quoted US stock market indexes, reached an all-time market high of 28,164.[i] However, unlike prior stock market highs, this new record seemed to be shrouded in fear that the market was teetering at the top of a mountain with an ominous downward sloping path ahead. Whether the predicted future stock market downturn is true or just good attention-grabbing headlines is yet to be seen.

However, the discussion gives way to an opportunity to revisit your current investment philosophy. Admittedly, many investors don’t have a sophisticated strategy other than to get the best return with the lowest amount of risk. In a good stock market, a loose investment strategy can seem sufficient. However, in the market to come where volatility is the new norm and no rules are the new rules, a sounder investment philosophy would be prudent.

Foundations of a sound investment philosophy include factors of returns that are persistent, pervasive, robust, implementable and intuitive.[ii] For example, style factors such as asset class investing might group Large Cap stocks into a group of securities with capitalization attributes ($10 billion+) that are associated with specific expected returns. Another factor or investment grouping is Small Cap stocks, which have different attributes of capitalization ($300 million to $2 billion) and different typical responses to macroeconomic factors. By grouping various factors together, academic and industry research leads to an expected return that can then be analyzed to meet the outlined philosophy goals mentioned above.

For example, research has indicated that Small Cap stocks tend to outperform Large Cap stocks in a long-term (10 years+) investment window.[iii] In analyzing whether Small Cap stock would be a sound investment philosophy, the returns of Small Cap stock should be persistent, in that the asset class continues to outperform its larger counter-parts in spite of obstacles and opposition, and throughout various historical market cycles. Following the sound investment strategy philosophy, the factor should also be pervasive, such that the rule of outperformance applies to the asset class throughout many world markets and is not singular to the US stock market. The factor should also be robust, meaning the adherence to the rule of outperforming should be measurable and meaningful. To have a valuable investment philosophy, the strategy must also be implementable in the real-world stock market. There must be a clear way to measure capitalization, sort companies by size and easily invest in small companies. Finally, investment in the factor, such as Small Cap stocks, must intuitively make sense. Small Cap stocks are subject to more volatility and more risk. Therefore, the investor must be adequately rewarded for the additional risk undertaken.

It would be easy to say that Small Cap stocks in the U.S. have consistently underdelivered in the last market cycle and dismiss the investment holding. However, a prudent investment strategy would be to analyze the philosophy, determine logically that an investment in Small Cap stocks makes sense and overcome the emotion as a disciplined investor. In fact, economists in the market anticipate that Small Cap has a good probability of taking the lead in investment returns in the next 12 months.[iv]

While we used an investment in Small Cap stocks as the factor in this example, the same philosophical examination of each portfolio holding can be done systematically to ensure each piece of your investment portfolio makes sense for you individually. Large Value and Emerging Markets are additional asset classes that have not fared well in the recent history, yet academically prove to be valuable pieces to a sound long-term investment strategy and a diversified portfolio.

On the flip side, consider an investment factor that doesn’t intuitively make sense. For example, what if the factor of grouping investments chosen was simply a letter of the alphabet, such as the letter “A”. Under such parameters, you might invest in Apple, Amazon, and Alphabet (Google), and the portfolio likely would have done well over the last 10-years! However, the letter A as an investment philosophy doesn’t hold up to the sound investment philosophy rules of persistence or intuition. In the long term, this tech-heavy portfolio would be subject to a great deal or risk and volatility for a retiree hoping to protect their life savings.

In summary, the investment philosophy you implement should make sense for your specific investment risk tolerance and long-term goals. A good investment strategy should have a foundation of historical evidence or academic support that can take emotion out of difficult decisions. When dealing with your life savings we want to be prudent rather than chasing a trend or leaving an investment up to chance. If you have questions about your current investment strategy, seek the opinion of a Certified Financial Planner™ to help you reach your financial life goals.

The commentary on this website reflects the personal opinions, viewpoints and analyses of Kondo Wealth Advisors, Inc. employees providing such comments, and should not be regarded as a description of advisory services provided by Kondo Wealth Advisors, Inc. or performance returns of any Kondo Wealth Advisors, Inc.  Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Kondo Wealth Advisors, Inc. manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.