What Is A Good Investment?
Discover How You Can Turn Bad Investments Into Good Ones Using Risk Management, Strategy, And Timing.
Key Ideas
- Explains why investment process matters more than investment product.
- Learn 3 methods you can use to earn consistent profits.
- Reveals 3 need-to-know characteristics of good investments.
Seems obvious, doesn't it?
Good investments make a profit, of course.
But this glib answer avoids the real issue…
Today, everyone wants to know if precious metals are a “good investment”, 5 years ago it was real estate, and 15 years ago it was technology stocks.
It's the same mistake over and over again – everyone thinks in terms of product.
If you want to become a great investor, forget about looking for a “good investment” and start focusing on risk management, timing, and strategy.
Stop thinking in terms of “product” and start thinking in terms of “process”.
This distinction is critical to your long-term investment success.
Let's see how it works.
Get This Article Sent to Your Inbox as a PDF…
What's the Difference Between Product and Process?
Bob the broker calls up Johnny Customer with the latest hot tip from his research department.
“Johnny, stock XYZ is undervalued. Our research shows good things coming down the road for this company, and we recommend buying it,” says Bob.
Bob is selling a product – not a process.
Notice there is no discussion of the investment process involved (in this case – active stock selection). Instead, the focus is on the stock which means critical questions will be overlooked.
- Where is the long-term research showing a positive mathematical expectation for prior recommendations?
- How will you know if the recommendation is wrong, and what criteria do you use to decide when to exit (risk management)?
- What percentage allocation is appropriate to any new position (risk management & strategy)?
- Assuming the research department is right and the stock rises, then how do you decide when to sell? What do you replace the position with and why (strategy)?
In short, what is the investment process and how does it work? That's the relevant question.
Surprisingly, few people focus on that question.
Instead, everyone wants to find the next good investment. They want a magic pill. They want to find the next Microsoft or Google in its infancy.
Sorry, long-term investment success doesn't work that way.
It's a process.
3 Ways to Profit by Getting Just One Thing Right
For example, at the height of the real estate debacle in 2008-2009, everyone agreed houses were a bad investment. Investors were going broke, and prices were in record free-fall.
However, you could still make a great investment if you had a strategy that bought foreclosures and abandoned property at 20 cents on the dollar.
At the right price, any asset can be a tremendous investment – including an asset where the price is declining rapidly.
In this example, the product (real estate) was a terrible investment, but with the right process (a risk management strategy), it could be an excellent investment.
How? Because you can convert a declining asset into a good investment without regard to market conditions when the margin of safety built into the intrinsic value of the price justifies the risk.
The key principle is the risk management process – not the investment product it's applied to. It's about process – not product.
Similarly, most people lose money trading options. The stats are abysmal. Few investment experts would disagree that options are a lousy investment product for most people (except gurus selling options trading courses, naturally 🙂 ).
However, a viable, low risk strategy is to sell out-of-the-money puts on new positions you seek to acquire. This way, you can add current income to your portfolio while potentially acquiring new stocks for less than they are selling today.
A generally “bad” investment product for most investors can be turned into a low-risk source of income when the right strategy (process) is applied.
The truth is there are no bad investment products. They are neutral and have known characteristics. However, there are bad strategies applied to investment products.
Continuing with examples, gold has been in an 11 year bull market.
Gold isn't an inherently good investment product as anyone who owned it during the '80s and '90s can attest; yet, every now and then, it has a day in the sun.
What's relevant is a valid timing process that can keep your capital out of the long-term bear markets and in the long-term bull markets. Again, it's about process – not product.
So, what can we learn from these three examples?
3 Characteristics Of A Good Investment
From all the above examples there are three ideas you want to note:
- If you get the timing right, you can be wrong about valuation and strategy, yet still come out with a profit.
- If you get the valuation right, you can be wrong about timing and strategy and still come out with a profit.
- If you get strategy right (have a positive mathematical expectation with good risk management), your profit is assured over time even though any single investment can fail on timing and valuation.
The key is to realize there is no such thing as an inherently good or bad investment.
Successful investing is all about process: risk management, strategy, and timing. It takes work and effort.
Everyone wants to know, “What is a good investment?”, but it's a fundamentally flawed question that sends your thinking in the wrong direction. It's the myth of the magic pill – a one stop solution.
Good investing is all about risk management, strategy, and timing.
It's all about process.
So please share your thoughts on this subject. Did you gain new insights, or am I missing something? I would love to hear what you think and thank you for joining the conversation…
Invest Like Todd!
A better investment strategy than buy and hold - Makes more by risking less
Discover the scientific investment process Todd developed during his hedge fund days that he still uses to manage his own money today. It’s all simplified for you in this turn-key system that takes just 30 minutes per month.
Thanks Todd,
A very clear and understandable article. Thank you for your great advice! It is interesting how you can as an individual apply these concepts to one kind of investment and then not to another. I find stocks difficult to manage on this level but real estate so much easier to handle. I just can’t help myself from buying the next great stock in the next great industry with unlimited potential only to be disappointed. Ie chip stocks and telecom late 1990s, wireless in the 2000s, the Ipad service stocks recently. I feel like a sucker falling for the same thing (product) over and over. I don’t rely on others to manage my real estate so I make sure my investment decisions are sound. Stocks are smaller investments and I am relying on others (analysts) for their advice. Once you buy the stocks they are not there to help you manage them they just recommend the next hot pick. Thank you,
@Steve – You’re welcome.
I started out the same way as I explain in this post.
Nobody is born a natural investor: it has to be learned.
That is what I do in these articles… I try to share the benefit of my decades in the trenches learning so you don’t have to make the same mistakes.
I’m glad you found value in the article.
Thanks for taking the time to share your thoughts…
Thanks for the article
Very few people look at the risk/benefit. Very few know anything about the fundamentals of the company they invest in. Many dont look for dangerous upcoming issues like the european debt problem. Most do not have an entry and exit stratagy. In summary most people that get into the market, Including 401K accounts, are set up for huge loss.
The PROCESS is very important. Maybe more important the What you invest in……
Thanks for the article
@Tom – Yes, it is not an obvious thing. The media and the investment product sales industry trained investors to think a certain way – about product. Thinking in terms of process requires a greater level of sophistication so people are resistant. They just want a “good investment” so they can be done with it. People don’t want to be confronted with the idea that it is constant work and requires constant vigilance. It is a process.
Thanks Todd, very good article.
My Broker recently called me on a particular stock, which I bought but this was a one off situation. Generally we discuss, give some thought to the particular stock and then buy / not buy. It is timely article for future investing scenarios.
@Ted – Given your broker’s pattern it sounds like this article could invoke quite a shift. Good luck. I hope it helps… and thanks for participating in the discussion.
The more I know about investment the more I realize that process and careful study/research is actually more important than product. A smart stock trader can probably take a really rotten stock and make money with it if he uses his long/short/call/put options carefully.
Think about many of the good “products” you know about . It was hard research and development that lead to a very good product. It was the “process” of R+D that made it a good product. Process is very important.
Good investment is a process and skill. It is not Luck. It is not gambling. It is something one needs to learn.
@Tom – Yes, it appears that it takes experience to get past the “product” illusion and recognize the importance of process. Hopefully this article accelerates a few people’s experience…
Dear Todd,
I have to admit, I’m a fan. That’s not something I would say about most advisors in the market. Having held a Series 7 & 66, and serving in the industry for a brief time was disillusioning. Your last piece about process, not product, was spot on. I think most advisors, like many investors (gamblers), are basically lazy, and seek immediate gratification.
So why can they get away with simply hawking product without concern for process? Because they can. People want the “big score”, and that’s what they are sold. It’s sad, really.
I remember one of the reasons many fail the Series 7 exam, is difficulty with the Options section. As you point out, Options are a losing game for most. But people are willing to risk money just for the thrill of explaining an Iron Condor at a cocktail party!
You wrote a piece a while back, which asked the question, “How much is enough?” Personally, I would like to see more of this topic scattered between the pure investment news. People say they want more money, but typically can’t tell you why. More money is fine, but to what end? It’s been said that people spend more time planning a vacation than they spend planning their retirement. We need to teach people to think from the end and plan accordingly. Otherwise, why are we playing this “investment” game?
Out country is in serious need of a change in the thought process. Once again, it’s not about the product (thought), it’s about the correct process.
I think you are helping bring about that change. Thanks for the good work.
@Michael. Thank you! I appreciate your sharing your experience and insights.
Thanks for a timely article. The basis of this article can be applied to any portion of your life and especially to business. Process is always important the problem is having a good one and being able to effectively apply it. In stocks you have a variety of indicators to use either indivdually or collectively. Which to use and at what levels is the real problem.
@Barry – Yes, you can only know the answer through testing. It is a challenging balance of science and art.
I also agree with your insight that these truths can be applied to any part of life. That is one of the reasons I’m passionate about these subjects – it is dealing with universal truths that are much deeper than just making money.
Thanks for bringing these points to the discussion.
Now I get it. Good investment depends on three factors – risk management, strategy, and timing. Sell process, not product. Thanks for sharing these information!
Point well taken, Todd.Your approach applies to the purchase of life insurance as well.It’s not about the product – it’s about the strategy.The product helps you execute the strategy.
Todd it is always a pleasure to read your posts. They are the most insightful investment related articles I receive. Thanks for sharing! I look forward to you picking up your podcast series again, when your schedule permits.
Thank you so much, Irwin. I really appreciate your encouraging words.
Timing, opportunities, and the ability to be agile are very helpful.
Thanks.. looking forward to it…