An investment strategy is the set of rules and behaviors that you can adopt to reach your financial and investing goals. Choosing an investing strategy can be a daunting task when you are starting to learn about investments and finance. Here we will look at the larger overall strategies rather than very specific strategies.
Given that this is such a broad term there can be strategies that go from the top (Overall Portfolio Strategies) to the bottom (stock-picking strategies). You can decide on a strategy starting with an overall strategy and then select more specific strategies (top – down approach) or similarly you can look at a specific strategy and select the overall strategy that goes with (bottom – up approach).
What’s important to note is that a strategy can incorporate multiple strategies, practices and tools. Doing one strategy does not always mean that another strategy cannot be used in conjunction. What’s most important is finding your own strategy and familiarizing yourself with all the different strategies and financial tools that are available so that you can make a decision that is well suited for you.
Picking a Strategy
Strategies
Given the huge number of strategies and variations within strategies we are only going to review common strategies. The level of risk for most is highly dependent on the type of investments made, rather than the strategy itself. The most popular strategy that is used by most investors that would go to a bank or an investment firm, for example, is a mix of diversification and asset allocation.
Random picks: Picking a large amount of random stocks has been found, on average, to be more successful than the vast majority of trading strategies.
Follow: Involves following whatever stock is “hot” at the time.
Buy and hold: Involves simply buying stocks and holding them for a longer period of time.
Day trading: Considered to be fairly risky trading strategy of buy and selling many times in one day to take advantage of fluctuations in the market.
Contrarian: Involves doing the opposite of the current market sentiment. Buying when everyone is selling and selling when everyone is buying.
Cyclic: Involves trying to time market ups and downs and trading accordingly, usually done with technical analysis.
Technical: Using Technical analysis to make decisions.
Fundamental: Using Fundamental analysis to make decisions.
Income: Finding assets that give income on a regular basis (such as dividends)
Growth: Finding assets that will have high potential growth but little current income.
Diversification: Choosing a large number of stocks or assets to reduce risk.
Asset Allocation: More of a guideline than a strategy, that can help with determining the correct amount of investment in each asset type.
As we’ve seen, even a buy and hold strategy can be incredibly complex depending on the specific strategy you use and the level of analysis made. What’s important is to tailor your strategy with what you are trying to accomplish. Someone who needs money right away but is risk seeking and has a great deal of knowledge may consider day trading to be a very viable option. Similarly, someone who has decades to invest and moderate risk aversion may still want to try his hand at day trading.
Passive Vs Active
Overall Strategies can also be broken up into passive and active categories:
Passive strategies are just that, passive. After making the initial decision to purchase a stock, investment, etc. the passive investor will keep it for months or years without making large changes. An example of this is someone like warren buffet who generally holds stocks for long periods of times and does not make changes to his holdings very often.
The active trader, however, will trade multiple times a week or even per day and will constantly evaluate what he is doing. Day traders are the most obvious example of an active trader.
It’s important to note that passive and active trading is over a spectrum, so someone who makes a few adjustments to their portfolio a few times a week could still be considered passive depending on the size of his portfolio for example.
Liquidity, Risk, and Potential Returns
All investments balance liquidity, risk, and potential returns. The balance among these three areas depends on your own individual taste, but how you view them will determine what kinds of investments you choose.
- Liquidity: Liquidity refers to how easily and quickly an asset can be converted into cash without losing its value. High liquidity means that the asset can be sold quickly at a fair price, whereas assets with low liquidity might take longer to sell or might require a discount to attract buyers.
- Risk: In the context of investments, risk refers to the degree of uncertainty about the possible outcome. High-risk investments have a greater chance of losing money, but they may also offer higher potential returns. Low-risk investments are generally more stable and reliable, but they tend to offer lower returns.
- Potential returns: Potential returns are the possible profits or gains an investor could earn from an investment. Investments with higher potential returns are usually associated with greater risk, as there’s more uncertainty about whether the investment will actually result in a profit. Conversely, investments with lower potential returns are typically less risky but also have limited profit potential.
Don’t Keep All Your Eggs in One Basket
Diversifying your investments is crucial at various levels, not just between asset classes, but also across sectors. Start by allocating your assets among different security types. For instance, a classic approach involves investing 50% of your savings in real estate, while the remaining 50% is divided between stocks and bonds. This way, if housing prices decline, your investments in stocks and bonds can provide some protection. Similarly, if the stock market falls, your real estate and bonds could help stabilize your portfolio.
Bonds are generally safer investments since their value is tied to prevailing interest rates, making them less susceptible to market fluctuations. They can also be beneficial during a rise in housing prices, stock prices, and interest rates, further reinforcing the importance of diversification.
Use an Evolving Portfolio
The traditional advice to invest in “more bonds as you get older” stems from the belief that your portfolio should become more conservative as you approach retirement. The idea is to minimize risk with your money as you near retirement age. If your stocks lose value when you’re 25, you have around 40 years to recover the losses before retiring. However, if your stocks decline in value when you’re 62, it’s much more challenging to compensate for the lost income, emphasizing the need for a lower-risk investment strategy in later years.
