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Investing without a framework is financial suicide

June 5th, 2011

8 Comments

Daniel

Valuefolio.com

At my home we have a basic framework with which we view life and make decisions. This framework helps us to make sensible decisions without letting our emotions get in the way. Here is an example of two of the principles in the framework that my wife and I have developed over the course of our marriage.

  1. Time is precious. This means that I don’t have time to sit around and cut coupons to save a few dollars. This time is better spent enjoying moments with my family. At our house there is no dollar value that will take me away from spending quality time with my family.
  2. Face-to-face communication is valuable. We don’t play with our smart phones at the dinner table. We don’t answer calls when we are spending quality time with each other or with friends. We put our gadgets away when it is time to spend time together.

These principles guide decisions we make every day in my family. Similarly, a framework should be developed for investing.

Pat Dorsey, author of The Five Rules for Successful Stock Investing, claims,

Before you start investing you need to have a framework from which you make investment decisions. Without a solid framework it is easy to fall victim to psychological biases. (p. 1)

The first step to creating an investing framework is to develop a set of investing principles. I think every investor should take the time to develop a set of principles that are core to his or her investment strategy–principles they are proud enough to frame and put on their office wall. So after spending some time brainstorming, re-writing, re-wording, and re-thinking, I’ve finally came up with foundational principles for my investing framework:

These principles set the framework for every investment decision I make. If an investment doesn’t fit into this framework then there is no room for it in my portfolio, plain and simple.

I like to break rules, but even for rule breakers, a foundation is needed. Let’s define each principle.

  1. Get your hands dirty: thoroughly research each investment before making an investment decision.
  2. Demand a moat: Ensure the business has a durable competitive advantage
  3. Leave room for error: Demand a large margin of safety. In other words, buy the business at a discount to its fair value.
  4. Invest with conviction: Don’t make an investment unless you have a deep conviction about the investment potential.
  5. Know when to sell: Decide at what point you would sell this investment and stick with your decision.

I encourage you to develop your own set of principles. Put them somewhere where you can see them. Make it look important. As Pat Dorsey said, this will save you from psychological biases. Who knows how many thousands of dollars something as simple as this could save you?

What are your investing principle? What makes up your framework? If your not sure, think about it like I did, write it down, and share it with us!

(This is a guest article by fellow value investor Daniel from ValueFolio.com. If you want me to post an article, contact me.)

About Daniel Sparks

Daniel Sparks has written 13 value investing articles.

Daniel Sparks is a passionate value investor with a specific interest in behavioral finance and its implications on investing. He is the author and founder of Value Folio, a value investing blog.

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  • http://jackfoley.net Jack Foley

    U have a great attitude and your priorities right

    no dollar value is higher than spending time with your family, cool..

  • http://www.valuefolio.com Daniel Sparks

    Thanks Jack!

    I seriously believe that simple attitudes like this toward life are the foundation to success. I know the blog post had nothing to do with that relationship, but it really is true, no doubt. It seems like Jae Jun has this down very well. That’s one of the reasons I love following this blog.

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  • http://jackfoley.net Jack Foley

    Yea I try to live my life based on these principles in order

    1. Health
    2. Family
    3. Wealth

    Therefore my family always come before cash. sometimes i always have to remind myself though.

  • http://www.plannedfreedom.com Dr. Capital

    Couldn’t agree more. It’s not even the choice of approach – value, GARP, contrarian, etc. It’s what Bruce Greenwald calls a “well-conceived investment process.”

    My personal challenge has been the “know when to sell” part. Take CSCO. I bought it at around $20, thinking it was a great value then. Well, now down almost 25%, it is even cheaper. Do I just decide that the market knows something I don’t and cut my losses, or buy more? Revaluation indicates an intact thesis… I should buy more but… It’s difficult!

    So I’d like to add one thing to the post. “Have the courage to stick with your investment process, but adjust and refine it as necessary.”

    By the way, what are your thoughts on GRVY? I know it has not done well recently…

  • http://www.oldschoolvalue.com Jae Jun

    Your situations with CSCO is the same as what I am experiencing with ARO. I bought, and now am down 20%. I did end up buying more though but I built a position that I am satisfied with which makes it hard to buy more unless it really does plummet more.

    A simple way to rephrase what you just said is what Joe Ponzio of F Wall Street has preached. Use price as a tool and not an indicator.

    That’s the same with GRVY. The investment thesis is still the same. The game is being delayed over and over again and it really is hard to play a waiting game where management cannot meet release targets, but the downside is virtually nonexistent and the upside is huge.

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  • http://www.valuefolio.com Daniel Sparks

    Thanks Jack. I definitely think simple family values like these are fundamental to business success. This may not deal directly with this post, but it is definitely a topic a whole book could be written about. What do you think?