6 Signs of a Good Investment Process
In my baseball-playing days, I was on the mound in a big playoff game, and at a key moment in the game I threw what seemed to be a good pitch, only to watch as the ball sailed over the fence for a home run. It might still be traveling somewhere over North Jersey, it was hit so hard.
Results – the bottom line – are what what ultimately matter. And results are typically easier to assess and more objective than evaluating process.
But investors often make the critical mistake of assuming that good outcomes are the result of a good process and that bad outcomes imply a bad process. In contrast, the best long-term performers in any probabilistic field…all emphasize process over outcome.
When the market is strong, it’s easy to fall into a false sense of confidence about your investment process because you’re receiving almost daily positive reinforcement from rising stock prices. The opposite is true when the market is down — you could have a good process experiencing bad short-term outcomes.
It’s important to remember that there’s a lot of randomness and luck involved in short-term market outcomes and they aren’t indicative of investing skill.
What really matters is whether or not your investment process can survive short-term periods of positive and negative reinforcement and deliver longer-term results. In a probabilistic field like investing, a good process will produce good results over time and over a large sample.
How do you know if your process is any good? Each investor will have his or her own process, but in my experience I’ve found six common traits of a good investment process:
- Stoic: It can endure both good and bad short-term outcomes without getting emotionally swayed in either direction.
- Consistent: It doesn’t adjust to current market sentiment and sticks to core competencies.
- Self-critical: The process is periodically reviewed, includes both pre-mortem and post-mortem analysis on decisions, and is refined as needed.
- Business-focused: Rather than rely on heuristics like “only buy stocks with P/Es below 15,” a good investment process focuses on understanding things like the underlying business’s competitive advantages (if any) and determining whether or not management has integrity and if they are good capital allocators.
- Repeatable: A process gets more valuable with each application — insights are gained, deficiencies are noticed, etc.
- Simple: The less complex, the better. If you can hand off your process to another investor without creating significant confusion, you’re on the right track.
Categories: Investment Wisdom