If you do not aim for anything, you will miss it every single time, goes the saying. This statement neatly captures what is at the heart of our outcome-based investing philosophy. Any measure of success requires that we define an objective, and it creates the frame around which you build the purpose or the “so what” of investing. The objective gives direction for all investment decisions, the monitoring of those decisions and measuring whether you are successful.
Our outcome-based investing approach is built around three key considerations: defining the required end goal (investment outcome), how much time you allocate (time horizon) and how much risk you are willing to take (risk budget).
These three factors work in concert and are not mutually exclusive. For example, if you set a high expected return outcome you need to lengthen the duration as well as allow for more risk in the risk budget. Conversely, if the return expectation is lower, both the duration and required risk budget can be shorter and more conservative.
If you have defined your goal or purpose and understand, and indeed anticipate, what could go wrong, you will be in a significantly better position to navigate the discomfort of being exposed to the volatility of markets.
Another fundamental component of an outcome-based investing approach is that it is not a guarantee. Any endeavour that involves risk-taking implies that things can and will go awry from time to time, not meeting your expectations. Being able to measure and calibrate this possibility is one of the key benefits of the approach. There inherently are trade-offs when approaching an investment from an outcome-based perspective; mixing the ingredients of desired return, duration and risk which informs the probability for success and very critically becomes the basis for expectations management.
Viktor Frankl stated that “he who knows the why can tolerate any how”. Although Frankl said this in a radically different context than managing investor behaviour, the thought process is a useful tool. If you have defined your goal or purpose and understand, and indeed anticipate, what could go wrong, you will be in a significantly better position to navigate the discomfort of being exposed to the volatility of markets. This will be even more so as the risk you need to take increases in proportion to higher return expectations.
As an investor that follows an outcome-based investing philosophy, it has been incredibly useful for me to always reflect that the future cannot be predicted with any great deal of accuracy. Yes, there are trends, relationships and patterns that are stable through time, but from an investment perspective it is well worth remembering that there is no such thing as a sure thing. Here the magic of diversification within the context of a risk budget is critical.
The reality for investors is that we cannot manage return, we can only manage risk. The return is the result of the nature and size of risks that you take with your investments.
The reality for investors is that we cannot manage return, we can only manage risk. The return is the result of the nature and size of risks that you take with your investments. Therefore, when considering your clients’ investments, the interplay between the risk budget and risk management is key. Ultimately you want to take a number of good quality risks.
As an example, trying to the predict the outcome of a coin toss is a bad quality risk. Although there is a good chance that you can guess the outcome of the next coin toss, it is inevitable that you will get it wrong. Predicting the weather over the short term is an example of a good quality risk – through careful observation and well-established models, you are relatively sure (although not certain) that when a weather forecaster (or app) predicts rain tomorrow, it is likely to happen.
This also applies to investments. When considering the nature of the investments that your client has made or are exposed to, it is worthwhile to consider the nature and number of risks that have been taken. Investing is personal, and therefore it is important to consider the risks in the context of their risk budget, duration and expected return; in other words, the outcome-based approach. This is a far more appropriate way to approach an investment and will significantly enhance the chance of your clients achieving their desired outcomes and personal financial goals.
Ultimately good investor behaviour, making well informed decisions, anticipating and not over-reacting to short-term disappointment and noise, are the ingredients to keep your clients invested for the long-run. These are the building blocks of outcome-based investing and staying invested, more than anything else, is the greatest guarantor of investment success.
Momentum Investments is part of Momentum Metropolitan Life Limited, an authorised financial services and registered credit provider (FSP 6406)