I am often asked a question: How do I set up my own investment system?
This is a big question, and I often see a variety of answers, usually including “What to buy?” “And” When?” “, “How much?” “, “When to sell”, “How to correct errors?” And so on.
But I don’t think that gets to the heart of the problem. There’s more to it than just a few questions.
I rereadthe investing habits of Warren Buffett and George Soros. I happened to see a picture in the book. I think it can be a very good answer to this question.
It’s a really good chart, it’s a comprehensive summary of all the factors needed for the whole investment system.
I have divided this picture into three parts:
1) Personal perception and investment philosophy;
2) Investment strategy;
3) Error correction mechanism
When we usually talk about the investment system, we are talking more about the second part of this — investment strategy. But actually, the other two parts, especially the first part, are more important.
I’m going to talk about this in the next few issues, but I’ll start with the first part today.
Three years ago, I wrote an article called “Investment is the realization of your cognition of the world in the secondary market”. At that time, I could only feel it vaguely, but now I feel it more deeply.
In the investment world, whether you buy or sell, or hold money, every decision an investor makes is based on his view of how the market works, or, rather, on his investment philosophy. Van Tharp, a famous investment philosopher, once said, “What you trade is not the market, but the ideas about the market.”
The investment gurus we have seen, whether Graham, Buffett, Soros, Fisher, Dario, all have their own investment philosophy. Every investment idea and every investment decision they make is developed from this investment philosophy.
Maybe that’s too abstract, but let’s give you some examples.
In Buffett’s investment philosophy, all he’s looking at is the value of the business — in this case, the future value of the business. When he looks at a company (that is, the company behind the ticker symbol), with decades of experience as a business analyst, he can quickly picture the company 10 to 20 years from now. A simple comparison of that picture and what the company looks like now will allow Buffett to decide whether to pull the trigger.
You mustn’t think it’s easy. It’s hard to see what a company will look like 20 years from now. In addition to talent and hard work, Buffett has ensured this in many ways, such as the circle of competence (see only those companies you can understand), the moat (companies with competitive advantages survive long), and entrepreneurship (people create value in companies).
In the investment philosophy of Buffett’s teacher Graham, he focused on the value of the business today. He looks for companies whose current, book, or liquidation values are significantly below market prices, buys them, and then looks for opportunities for value reversion — either by means of mean reversion to market prices, or by active liquidation, acquisition, etc.
And then there’s Soros. Soros has been interested in philosophy all his life. He believed that the market is composed of people, and the price of the market is determined by people’s knowledge (including the right knowledge and the wrong knowledge). If you’ve read The Alchemy of Finance, you’re familiar with the term reflexivity. Soros argued that “boom-and-bust processes occur only when market prices affect the so-called fundamentals that are thought to be reflected in market prices”. Seeking and seizing such opportunities is Soros’s investment philosophy.
If he finds the reflexive process that is controlling the market, and if the trend continues for some time, and prices become much higher than most people predict, he will pull the trigger.
Why is investment philosophy important? The investment philosophy is the foundation of the investment system, and it determines everything below — including “what to buy?” “And” When?” And so on.
Take buying a stock.
When Buffett buys a stock, it’s because he can see how much money the company will make over the next 10 years — that’s how much the company is worth today. If the market price is much lower than that, he will buy.
And when Soros buys a stock, it’s because the perception of the people behind the price of the stock has formed a reflexive process that determines how high the price is likely to go.
Next,
If the stock goes up, Buffett may stop buying it. Because in his investment philosophy, this price may exceed the margin of safety he can afford. And Soros is likely to increase his position significantly because Mr Market has given him the right response, confirming his hypothesis.
If the stock goes down, Mr. Buffett may buy it because the margin of safety is greater. But Soros may be pulling back altogether, as Mr Market is telling him you may be wrong.
“For what? “And” When?” “, “When to sell”… Buffett and Soros are very different about how these systems work, but if you look at it from an investment philosophy point of view, it fits perfectly with their respective investment philosophies.
Another example is “concentrated investment” or “diversified investment”, which is often discussed “investment system” problem.
In fact, this is also determined by the investment philosophy.
The investment philosophy of Buffett and Munger is more of a business analyst, looking for business models, looking for entrepreneurship, looking for people to trust within their own circle of competence. When they find the perfect opportunity, they make big bets.
Mr Schloss, also a value investor, takes a different approach. ‘I don’t have Warren Buffett’s ability to see the people behind a company and make them work for me,’ he once said. Therefore, Schloss uses the “under-diversification, not deep research” approach to form the basis of his investment system.
Mr. Market’s investment philosophy also determines how different investors view Mr. Market.
We often say “Mr. Market” in our weekly papers, but the previous discussions have been based on the investment philosophies of Warren Buffett and Graham.
“In the short run, the market is a vote-recording machine — it reflects short-term votes with only financial requirements and no regard for intelligence or emotional stability. In the long run, the market is a weighing machine,” Graham argues.
Both Mr Buffett and Mr Graham tend to believe that markets are unpredictable. They went out of their way to ignore the impact of “Mr. Market” on their investment systems.
In Buffett’s investment philosophy, the most important thing has always been value. So he put all his energy into the judgment of the future value of the enterprise. However, he uses “long-term investment”, “fund structure management” and other ways to ignore the influence of Mr. Market, so as to reap the growth of enterprise value in the long run.
Both Graham and Walter Schloss, another guru of value investing, tried to mitigate Mr. Market’s potential problems by “diversifying” and “stretching out the time of your investments.”
But Soros is the opposite.
Unlike Buffett, who thinks’ Mr. Market ‘is completely unpredictable, Soros’s reflexivity is his explanation for Mr. Market’s erratic mood swings and gives Soros the ability to read Mr. Market’s brain.
In his system, the source of return is itself profiting from the mood swings of “Mr Market”.
Therefore, “Mr. Market” is his best friend.
In his book The Investment Habits of Warren Buffett and George Soros, Mark Thiel identifies three main schools of investment philosophy. They are:
analysts
traders
An actuary
The “analyst” is represented by Buffett. He is concerned about enterprises and entrepreneurs, he believes that behind the stock is the future value of enterprises, the fundamental investment profit is the growth of enterprises.
The Trader is represented by George Soros. He has a unique sense of “Mr. Market” and is able to anticipate where the market will go next and try to profit from that trend.
The “actuary” is represented by Nassim Nicholas Taleb, author of books such as “Black Swan” and “Anti-Vulnerability. He studies numbers and probabilities. He is more concerned with the overall outcome than with individual events. His investment philosophy is to build an anti-fragile investment system that “does not predict, only respond”.
Mark Thiel’s three definitions are great, and if you translate them in a domestic way, they are:
Analyst: Value investing
Trader: Trend investing
Actuary: Quantitative investment
All the investment gurus you know, old and young, fall into these three categories (with a slight crossover). You may as well have a try.
Finally, let’s go back to the top of the chart.
On top of “investment philosophy,” there is a layer of “personality.” This includes goals, knowledge, experience, abilities, skills, interests, and I unify these in one word: personal perception.
Investment philosophy is developed on the basis of “personal cognition”.
What kind of person you are and what kind of world you see determines what kind of investment philosophy you will have.
Buffett, Soros and Taleb grew up in circumstances, personal interests and paths that shaped their perceptions of the world and ultimately their investment philosophies.
That’s important.
For most of us, we don’t need to have a complete investment system, but we need to have a philosophy.
Even when we’re not investing our own money, but we want to delegate our investment work, whether it’s to a VC, a private or public fund manager, or a portfolio manager, we have to know our own investment philosophy and preferred investment style.
Only then can we find someone to manage our money the way we do;
Only in this way, when our investment encountered a temporary dissatisfactory time, we can firmly believe him;
That’s how we’ll end up reaping good returns on our investments, as well as great relationships and personal growth.
From: Meng Yan