Explaining Your Investment Decisions
Updated: Oct 16, 2020
Investors face more scrutiny for the trades they make rather than the trades they pass up on. Which is ironic, considering most investors spend their time kicking themselves for investments they miss out on, such as a penny stock that quintupled in value overnight. Notwithstanding, each investor will face scrutiny over their investment decisions, whether from colleagues, clients, family, etc. Here's how you defend yourself:
Always have an investment philosophy, otherwise known as a reason for why you decided to invest. Before investing your money, you should know exactly what you are investing in, and how that investment makes money. For instance, if you decide to invest in Amazon by purchasing stock, it's not sufficient enough to buy stock just because it has done well in the past; investing is all about the future.
A better approach would be comparing Amazon to its competitors, and try to identify advantages that one side has over the other. Once you identify their competitive advantages, look for new tactics each company may be using to get ahead, and then try to determine which will make money (or more money) in the future. If you remember that a company's stock price is a result of expected future cash flows, then you'll be on the right track.
Be diligent in your research, actively try to prove yourself wrong. By identifying all of the weaknesses in your investment idea, you'll get an accurate picture of the risks involved. And each risk you identify can be treated as an exit sign on a superhighway - it's perfectly safe to get off the road and not invest. Rule #1, never lose money.
Identifying all of the pitfalls in an investment will have you thinking of counterarguments that you can expect when your investment decisions are scrutinized. The more time you spend identifying risks before you make the investment, the better off you will be.
The third and final step is to write everything down. Always keep track of the investments you make and your reasoning behind them. Trade logs are often very complex, detailing even the most seemingly pointless detail.
A good place to start is to keep track of: the date you invested, investment name, reasoning, risks, a small list of competitors to monitor, and a target price. This last bit is arguably the most important. Each investment made should have an expected target price that it's expected to reach; this may relate to stocks more than other types of investments. If you purchase Apple stock at $500 per share, you should know at the time of purchase that you plan to sell once it reaches $700 per share.
It's perfectly acceptable to make adjustments to the target price throughout the life of the investment; professionals update their investment models each time new information on a company becomes available, at least once every 3 months.