An investment strategy is what guides an investor’s decisions based on goals, risk tolerance, and future needs for capital. Some investment strategies seek rapid growth where an investor focuses on capital appreciation, or they can follow a low-risk strategy where the focus is on wealth protection.
The best investing strategies are not always the ones that have the greatest historical returns. The best strategies are those that work best for the individual investor’s objectives and risk tolerance. In different words, investing strategies are like food diets: The best strategy is the one that works best for you.
An investment strategy made popular by Warren Buffet, the principle behind value investing is simple: buy stocks that are cheaper than they should be. Finding stocks that are under-priced takes a lot of research on the fundamentals of the underlying companies. And once you’ve found them, it often takes a long time for their price to rise. This buy and hold technique requires a patient investor but should the right call be made, handsome payoffs could be earned.
A great way to build wealth over time, income investing involves buying securities that generally pay out returns on a steady schedule. Bonds are the best known type of fixed income security, but the category also includes dividend paying stocks, exchange-traded funds (ETFs), mutual funds, and real estate investment trusts (REITs). Fixed income investments provide a reliable income stream with minimal risk and depending on the risk the investor is looking to take, should comprise at least a small portion of every investment strategy.
An investment strategy that focuses on capital appreciation. Growth investors look for companies that exhibit signs of above-average growth, through revenues and profits, even if the share price appears expensive in terms of metrics such as price-to-earnings or price-to-book ratios. A relatively riskier strategy, growth investing involves investing in smaller companies that have high potential for growth, blue chips and emerging markets.
Small Cap Investing
An investment strategy fit for those looking to take on a little more risk in their portfolio. As the name suggests, small cap investing involves purchasing stock of small companies with smaller market capitalization (usually between $300 million and $2 billion). Small Cap stocks are appealing to investors due to their ability to go unnoticed. Small cap investing should only be used by more experienced stock investors as they are more volatile and therefore difficult to trade.
Socially Responsible Investing
A portfolio built of environmentally and socially friendly companies while staying competitive alongside other kinds of securities in a typical market environment. In today’s modern world, investors and the general public expect companies to maintain some social conscience, and they’re putting their money where their mouth is. Socially Responsible Investing is one path to seeking returns that poses a significant collateral benefit for everyone.
Once you understand the different investing strategies, now you want to look at the different portfolio strategies.
The Aggressive Portfolio
An aggressive portfolio portfolio includes those stocks with a high-risk/high-reward proposition. Stocks in this category typically have a high beta, or sensitivity to the overall market. Higher beta stocks consistently experience larger fluctuations relative to the overall market. If your individual stock has a beta of 2.0, it will typically move twice as much as the overall market in either direction.
Most companies with aggressive stock offerings are in the early stages of growth and have a unique value proposition. Building an aggressive portfolio requires an investor who is willing to seek out such companies, because most of them, with a few exceptions, are not going to be common household names. Look online for companies with rapidly accelerating earnings growth have not been discovered by Wall Street. The most common sector to scrutinize would be technology, but many firms in other sectors pursuing an aggressive growth strategy can be considered.
The Defensive Portfolio
Defensive portfolios do not usually carry a high beta and are fairly isolated from broad market movements. Cyclical stocks, on the other hand, are those that are most sensitive to the underlying economic business cycle. For example, during recessionary times, companies that make the basic necessities tend to do better than those focused on fads or luxuries. Despite how bad the economy is, companies that make products essential to everyday life will survive. Think of the essentials in your everyday life and find the companies that make these consumer staple products.
The benefit of buying cyclical stocks is they offer an extra level of protection against detrimental events. Just listen to the business news and you will hear portfolios managers talking about “drugs,” “defense” and “tobacco.” These really are just baskets of stocks the managers are recommending based upon where the business cycle is currently and where they think it is going.
The Income Portfolio
An income portfolio focuses on making money through dividends or other types of distributions to stakeholders. These companies are somewhat like safe defensive stocks but should offer higher yields. An income portfolio should generate positive cash flow. Real estate investment trusts (REITs) and master limited partnerships (MLP) are excellent sources of income-producing investments. These companies return a great majority of their profits back to shareholders in exchange for favorable tax status. REITs are an easy way to invest in real estate without the hassles of owning real property. Keep in mind, however, these stocks are also subject to the economic climate. REITs are groups of stocks that take a beating during an economic downturn, as real estate building and buying activity dries up.
An income portfolio is a nice complement to most people’s paycheck or other retirement income. Investors should be on the lookout for stocks that have fallen out of favor and have still maintained a high dividend policy.
The Speculative Portfolio
A speculative portfolio is closest to a pure gamble. A speculative portfolio presents more risk than any others discussed here. Finance gurus suggest that a maximum of 10% of one’s investable assets be used to fund a speculative portfolio. Speculative “plays” could be initial public offerings (IPOs) or stocks that are rumored to be takeover targets. Technology or health care firms in the process of researching a breakthrough product, or a junior oil company about to release its initial production results would also fall into this category.
Speculation may be the one portfolio that, to be done successfully, requires the most homework. Speculative stocks are typically trades, not your classic buy-and-hold investment.
The Hybrid Portfolio
Building a hybrid portfolio means venturing into other investments, such as bonds, commodities, real estate, and even art. There is a lot of flexibility in the hybrid portfolio approach. Traditionally, this type of portfolio would contain blue chip stocks and some high-grade government or corporate bonds. REITs and MLPs may also be an investable theme for the balanced portfolio. A common fixed-income investment strategy approach advocates buying bonds with various maturity dates and is essentially a diversification approach within the bond asset class itself. Basically, a hybrid portfolio would include a mix of stocks and bonds in relatively fixed proportions.
This type of approach offers diversification across multiple asset classes.
Setting up your investment strategy is like buying a new car, before you look at the different models, you need to figure out what style suits you best. And just like cars, there are many styles to choose from when creating an investment strategy. When choosing the right investing strategy, there are questions that need to be answered first. What is your investment horizon? What returns are you seeking to achieve? What amount of risk are you able to tolerant? What are the funds in this investment to be used for? Answering these questions will ultimately also help in building your portfolio.
In terms of specific investment strategies within your asset allocation, if you are a high risk investor with a long investment horizon, you may want to include small cap and growth investing in your portfolio. If you have a moderate risk tolerance and shorter investment horizon, you may be more suitable for value and income investing. If you have a low risk tolerance and short investment horizon, you may want to focus solely on income investing. It is also important to adapt to the investment strategy you are most comfortable with. Someone with a knack for choosing growth stocks may make that strategy the priority in their portfolio.
Determining what will be your breakdown between cash, fixed-income securities and stocks is a good start towards creating your investment strategy. The breakdown of your asset allocation ultimately depends on your risk tolerance. A conservative investor may prefer to hold 80% of his portfolio in fixed-income and 20% in stocks. The reverse would be true for an aggressive investor, while a balanced investor will follow a 50-50 split.
There’s no magic formula for managing your investments—but these few things come pretty close.
– When it comes to your investment strategy, building your portfolio the right way is half the battle. Focus on things you can control, like asset allocation and costs.
– For most investors, once your portfolio is set, there are only a few things you need to do to stay on track.
– Start with your asset allocation. Of all the decisions you make, your asset allocation could have the biggest impact on the performance and volatility of your investments.
– Protect yourself through diversification. The more bonds and stocks you own, the smaller the impact each one individually can have on your overall portfolio, which lowers your risk.
– Don’t let high costs eat away your returns. The amount you pay to invest has a direct impact on your returns.
Finally, here’s a look at six common investment strategies:
1. Top-down Investing – Top down investing strategies involve choosing assets based on a big theme.
2. Bottom-up Investing – Bottom up strategy chooses stocks based on the strength of an individual company, regardless of what’s happening in the economy as a whole or the sector in which that company lies.
3. Fundamental Analysis – Fundamental analysis involves evaluating all the factors that affect an investment’s performance. For a stock, it would mean looking at all of the company’s financial information to really understand what’s driving the company and where growth is coming from
4. Technical Analysis – Technical analysis involves choosing assets based on prior trading patterns. You’re looking at the trends of an investment’s price.
5. Contrarian Investing – Contrarian chooses assets that are out of favor. They determine the market’s consensus about a company or sector and then bet against it.
6. Dividend Investing – As the name suggests, dividend investing buy stocks with a strong record of earnings and dividends. Because of market volatility of recent years, many investors like the idea of a fund that offers them a regular payout. This also created a cash flow assets because of the periodic payouts.