Investmentdiscipline is not about knowing when a share is about to rise or fall and, therefore when is the best time to buy or sell it.

Investment discipline should not be about attempting to out perform the market on a daily basis, since the market is not always the best manager of risk and return.

While a market may be efficient in matching demand and supply given the information available in the market place, its ability to correctly price risk is limited by the human condition, fear and greed, and by its ability to value risks to the ability of assets to meet future liabilities.  Since the average human being is marginally irrational when it comes to investment decisions and since liabilities are not normally taken into consideration within the valuation decision, markets are not as efficient as they could or should be. This provides opportunities for those disciplined enough to understand, to value and to manage both risk and return. 

Investment discipline is the identification and management of value and not the identification and management of share price movement. 

Value means buying the future earnings of a company at the cheapest possible price.

Rising share prices means falling value and falling share prices means rising value.

There are thee main investment disciplines which offer value in terms of either their ability to out perform, or provide a below average risk, or a combination of both. These are value, growth and conservative investment disciplines 

Before we can truly understand investment discipline we need to understand why we invest in equities in the first place. 

What is it in fact, that we are buying?

When we are buying equities we are buying the future profits of companies that operate in the economy.  If a company did not earn more than we could get on cash, we would not invest in it. 

Therefore, the profits that a company makes has to be above the return on cash and lower risk investments. 

Because of this, by buying an equity we are really buying the additional return that an equity investment provides above the return on lower risk investments. 

 But why do we need a discipline when buying and selling equities?

Because the amount of additional return we can get by buying an equity depends on how much we pay for our shares in a company, we need to be able to value companies and, know when a share offers value or not.  This is investment discipline.

Investment discipline relies on the ability to value investments, to understand investor psychology and to focus on the underlying value of investments purchased, retained and sold and to view dispassionately the short term movement in share prices.  

Many investors and many investment managers do not have the important prerequisites of investment discipline.  Many are swayed by the crowd and what others are doing.

 Does investment discipline always = out performance?

No, it is virtually impossible to out perform the market at all points in time and under performance, if you are following a strong investment discipline is at times guaranteed.  Understanding why this is the case is important for investors and is discussed at length right throughout this website. 

Which investment style is best?

In the end it is not about investment styles, but about valuation and discipline.  Providing your manager's assessment of valuation and valuation risks are correct and, the resulting allocation is properly managed and relevant to your financial needs, your portfolio should have a good chance of achieving its stated investment objectives. 

Nevertheless, different styles and different market components all exhibit periods of out performance and under performance over time.  No one style or discipline is always dominant, but some styles and disciplines are more appropriate for investors who are either conservative or who have financial demands on their portfolios. 

What is important, is that your wealth managers are aware of these issues and are able to address the realities of valuation within portfolio management.

But, is active management really viable or should we all buy the index?

Index investments are suitable for investors who do not want to risk under performing the index, whatever the longer term benefits of a longer term active management style, but they are not a replacement for those who can stomach contrary investment disciplines.

However, it all depends on whether your advisors have the necessary investment discipline.  As noted, not everyone who manages money or who even knows how to value assets has the dispassionate attitude towards short term performance that is needed in order to successfully negotiate markets.

While most investors and most managers would be better off with an index approach, this does not mean that investment discipline is dead.  Those who can value, who have the intellectual freedom to adapt to changing market relationships and those with investment discipline will outperform.  But mathematics still states that it is impossible for the average investor to outperform.

Asset allocation, the new investment discipline?

No, asset allocation is not an investment discipline but it is often treated as such by much of the financial services industry. 

Your asset allocation that you receive from your manager should come from a bottom up valuation analysis of either the stocks, the markets or the components to which you are allocated.

Asset allocation is the end result of an investment process that relates your financial needs and risk preferences to the structure of your portfolio based on the asset manager's valuation process and investment style.  

Valuation, allocation and management

When we value an investment we are not just valuing how much it is worth.  We are also valuing how risky it is. 

When we combine investments we need to be able to allocate to investments in a manner which manages both risk and return.  More importantly we need to be able to combine investments that match individual risk preferences and financial needs. 

Finally, when market and security prices change, the relationship between each security's risk and return, the interrelationship between all securities' risks and returns and risk preferences and financial needs also change.

It is not just a question of being able to value investments, or to construct portfolios but to manage all these changing relationships.

If an organisation does not have a valuation, allocation and management framework that automatically, manages all these relationships, it will not be able to effectively manage personalisation.