Investors with no plan are referred to as Sheep. Arbitrary choices made for one’s investment portfolio are rarely rewarding. It’s true that the complexity of financial markets is intimidating. However, proven investment strategies can largely help investors bust this block.
In finance, an investment strategy can be understood as a set of rules or procedures designed to guide how an investor selects different financial assets or securities, such as stocks or bonds, in the hope of receiving even more money later on his/her portfolio keeping into account the profit objectives. An individual’s skills also play a significant role in making different approaches to investing successfully.
The different types of investment strategies help investors choose where and how after having considered risk tolerance, their expectation of a return, long-term and short-term holdings, retirement planning, preferred industries, and other miscellaneous aspects. However, sometimes, there may be situations that involve a trade-off between risk and return. Most investors around the world fall somewhere in between these two extremes that is they accept some risk for the expectation of higher returns.
Nevertheless, the whole point of committing one’s money or another resource is to derive some future benefit. For example, college education is a decision well thought of by students. It can be considered as an investment as they invest their time and money in hopes of earning a degree as well as getting a good job post-graduation.
Now, most investments deliver returns to the investor in the form of appreciation implying that the value of an asset has increased, and interest payments or dividends paid by the company he/she holds an interest in.
Over the years, experts have developed, and applied different strategies to investing that are discussed below.
- Passive and Active Strategies
Also known as Buy and Hold strategy, Passive investing refers to buying and holding the stocks of companies for an extended period and not frequently dealing with them to avoid higher transaction costs. This strategy is based on the concept that nothing can outperform the market due to its volatility and equity markets give a good rate of return in the long term. Thus, a passive strategy tends to be less risky.
Active strategies, on the other hand, require an investor to frequently buy and sell as they believe it is possible to outperform the market on the back of a proactive approach and derive higher returns than an average investor would.
- Growth Investing (Short-Term and Long-Term Investments)
Under this growth strategy, investors choose the holding period of owning a stock of a company based on the value they want to create in their portfolio. These are stocks of those companies that have delivered better than average gains to the shareholders and are expected to continue with the high growth rates. However, these projections are only based on empirical evidence, and the results are surely affected by the changing market conditions.
Importantly, these emerging growth companies may not have a long history of big earnings, but they do demonstrate a strong potential for high earnings. If investors are of the view that a company will grow in the coming years and the intrinsic value of a stock will go up, they will invest in such companies to build their target corpus value.
On the other hand, if investors estimate a company to deliver excellent value in the coming year or two, they usually opt for short term holding. Thus, the holding period depends upon the preference and time horizon of investors such as how soon they require money to buy a house, fund school education of kids, invest in retirement plans, etc.
- Income Investing
Income investing is a strategy focused on generating cash income from securities rather than investing in stocks that may or may not increase in value over a period of time adding to the increase in the portfolio’s value. The two most popular kinds of cash income which an investor can earn include Dividend Income and Fixed interest income from bonds. The risk-averse investors who value a steady income from investments usually opt for such a strategy.
- Value Investing
Value investing strategy, also used by the Oracle of Omaha – Warren Buffet, refers to putting one’s money into companies by looking at their intrinsic value as these companies are undervalued by the stock market analysts. The key idea behind such an investment strategy is that when the market goes into a correction phase, it may correct the value for such undervalued companies leading the stock price to shoot up, thus generating high returns to the investors when they sell the stock.
- Dividend Growth Investing
Under the Dividend Growth strategy, the investors lookout for companies that had consistently paid a dividend over the last few years at regular intervals. This is because companies that do pay out regular dividends are considered to be more stable and less volatile as compared to other companies. The companies also aim to enhance their dividend amount every passing year. The key benefit to an investor using this strategy is that he/she can reinvest such dividend and thus leverage the advantage of compounding over the long-term.
- Contrarian Investing
When the market is down, investors flock to buy stocks of companies so as to sell them when the market returns to a normal. This strategy advocates buying at low and selling at high prices. The downturn in a market may refer to a time of recession, war or even a natural calamity such as one going right now around the world, that is COVID-19 pandemic. However, one cannot blatantly hoard on stocks. Investors need to select companies that demonstrate the capacity to build up value over time and have a market reputation that prevents access to their competition.
As the name suggests, this sort of investing advocates allocating one’s money to a small portion of stocks in a market index, say S&P 500, mutual funds, exchange-traded funds (ETFs) and others.
- Momentum Trading
A simple strategy whereby investors can select companies to invest in based on their recent performance. Investors opting for momentum trading believe that a stock that generated higher returns in the last 3 -12 months tends to continue performing better over a period of time through the next few months compared to stocks that did not generate good returns.
Having an investment strategy can facilitate in ruling out the possibility of building a poor portfolio and will increase the odds of success. Also, it is very important to be clear with one’s objectives such as the capacity to invest, the expectation of a return, level of risk tolerance and time horizon. Investor starting out on a clear note can always make use of opportunities at hand and build a portfolio through careful research money by money.