One of my favorite investment quotes comes from Warren Buffet:
“To invest successfully over a lifetime does not require a stratospheric I.Q., unusual business insight, or inside information. What is needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.”
One of the key words in that quote is the word ‘framework’. The word framework to me relates to structure. It’s no different that building a house. A good house is built on a solid foundation and framework. What’s interesting is when you go to a new show home, what you see is the decoration and design. What you do not see is the most important part of the house, which is the framework behind all the paint and decor.
When it comes to investing, a solid foundation and framework is the key to investment success. Just like in a house, a weak foundation leads to potential problems and sometimes really big problems. Sometimes we focus too much on the sizzle and the stories and forget about what is really important, which is the foundation and framework.
In my opinion, the foundation of an investment portfolio starts with the investor. Every investor is different and unique. Every investor has different goals, a different tolerance for risk and different financial situations.
This is no different than the foundation of your home. The foundation you start with depends on the size of house you want to build, the type of home and where the home is being built.
In many cases, the financial industry uses investment questionnaires to establish a personal foundation for the portfolio. The questionnaire is designed to try to personalize the portfolio.
In addition to the questionnaire, investors should start by asking three basic questions when determining the foundation of your investment portfolio, .
- How much do you know about investing?
- How interested are you in being a good investor?
- How engaged will you be? How often will you review your portfolio?
Your long-term investment success is really dependent on the framework you create. In the investment industry, I equate developing the framework to determining the right asset allocation. Asset allocation is the science behind investing. Most people think that picking investments is the secret to success when asset mix is a greater determinant of long-term investment risk and returns.
Related article: The science of building a diversified portfolio
Asset allocation has been recognized as a very important part of the process of building a portfolio. In 1952, Dr Harry Markowitz published his research which evolved into what we call Modern Portfolio Theory. Modern portfolio Theory suggests that proper asset allocation is the key determinant of investment performance. More than investment selection, market timing and all other factors combined.
As a result, this time tested science is really the framework for investing. Get this right and it matters less what investments you choose and when you choose them.
There's an old saying that says “Spend time on minor things and you may get minor results. Spend time on major things and you may get major results.”
Related article: Model Investment Portfolios
I believe working on the foundation and framework of your investment portfolio is the major part of investing. Spend your time wisely. What do you think?