Investment Decisions: Asset Allocation, Stock Selection, & The Dynamic Duo of Investing

Investment Decisions

Investment decisions influenced properly by the concept of probability can maximize positive outcomes. In our last post, Making Probability Theory Practical for Investment we discussed how understanding probability would help us avoid short term prognosticators and concentrate on a long term investment plan. Now I want to concentrate on how investors can implement a long term plan using probabilities to increase and maximize positive outcomes.

The following two investment strategies combined will maximize your probability of meeting your goals for those who are willing to take a long term view.

Asset Allocation Investment Decisions

Although short term movements in the stock market are random; the positive bias makes long term investing much more certain.  We know that investing when valuations are low always produces positive rates of return when time horizons are 15 years or more. Rob Bennett at A Rich Life has done extensive research on this subject including a Retirement Calculator using different valuation scenarios. I encourage you to examine his tools for learning this important concept.

A flexible or tactical asset allocation strategy  is an important concept in using probability to improve your investment outcomes. Investing during periods when valuations are low greatly improves portfolio returns. Investing during periods of high valuations produces below average rates of return, even in the long run.

Stock Selection Investment Decisions

Valuation also works when making stock selection investment decisions. If you buy a variety of individual stocks with good fundamentals at low valuations the probability of positive outcomes is much greater than average.

My single favorite stock valuation calculation is ROEV, or Return on Enterprise Value (ROEV). This ratio compares the cash flow to the current market price of the company with an adjustment for its balance sheet. George at Fatpitch Financials has published a ROEV Backtest that demonstrates the value of this powerful investment research tool.

Dynamic Duo of Investing

A valuation based tactical asset allocation strategy with a ROEV individual stock selection strategy makes a powerful risk adverse combination. This dynamic duo of investing would change the investment world if people would follow it. But they don’t. They let greed and lack of knowledge lead to making investment decisions with poor probabilities. You know what works now.  There are many choices out there; only you can choose your path. You can make low probability investment decisions or high probability investment decisions.

Do you have the discipline to make high probability investment decisions?