How to Invest: 8 Investment Strategies to Consider
An investment strategy is a critical component of planning and executing a successful plan for wealth accumulation. But for newer investors and those just starting out, it’s hard to figure out what investment strategy to follow and if there are times to change course.
What is an Investment Strategy?
To start, let’s define what is an investment strategy.
Investment strategies are theories about how an investor should act—and where they should put their money—in order to grow their savings.
Investment strategies typically include:
- On overall philosophy about the market and the role of the investor;
- The types of investment products that best suit the strategy;
- When to invest using these products and the philosophy in order to maximize expected returns and minimize risk and taxes.
While an investor may start their wealth accumulation journey using one investment strategy, over time, the investor may opt to change strategies—a decision often prompted by objectives, goals and the investment timeline.
How to Choose an Investment Strategy?
When you first start your investment journey it can be difficult to decide how and where to invest. By learning about various investment strategies, you can choose to follow one strategy and this can help you stay on course, despite potential market turmoil.
To help you narrow down the strategy that best suits your needs and goals, here is a list of eight of the most common investment strategies in the current market:
- Passive Investment Strategies
- Active Investment Strategies
- Value Investing
- Growth Investing
- Income Investing
- Indexing
- Dividend Growth Investing
- Contrarian Investing
How to Invest Using Passive Investment Strategies
Passive investment approaches attempt to avoid the expenses and poor returns that might result from frequent trading and ill-timed trades.
The objective of a passive investment strategy is to buy the market—not beat the market.
Unlike active traders, passive investors do not strive to benefit from short-term price movements or market timing. Instead, the strategy’s basic premise is that the market will produce favourable rates of return over time.
The key to passive investing is to buy the market—usually through broad-based funds, such as balanced exchange-traded funds—and to hold these earnings over a long period of time.
Advantages of Passive Investing
Passive investors use indices to act as their benchmark. The goal is to buy broad-based funds or solid, triple-A-rated corporate stocks and hold these funds for a longer period of time.
Because there are no portfolio managers selecting stock and selling to take positions throughout the year, passive investment strategies tend to have some of the lowest fees of any investment style.
This buy-and-hold approach adopted by passive investing also typically results in much lower taxes consequences, when compared to other investment strategies.
Disadvantages of Passive Investing
Passive funds will never outperform the market, even during turbulent times, because their main assets are designed to track the market. There are times when a passive fund will outperform associated benchmarks but, by in large, passive investment strategies will rise and fall along with the market cycles.
How to Invest Using Active Investment Strategies
Active investors take a position—financial speak for buying or investing in a strategic way—with the sole purpose of trying to earn better (or faster) returns than the overall market.
A classic active investor is a portfolio manager that picks the individual stock and when to buy, hold or sell that stock, that sits inside a mutual fund, pooled product or exchange-traded fund (ETF).
Active investors can include buy-and-hold—for a period of time—but their strategy will eventually prompt them to sell and purchase other investments, in the pursuit of better earnings.
Unlike passive investors, who buy the market with no intention of beating the market, active investors will buy and sell frequently, based on their goals and strategies.
For example, a day trader is an active trader. In the classic definition, a day trader will start the trading day by analyzing the market to look for opportunities; buy based on their analysis, wait for the day to unfold and then sell everything at the end of the day to capture the earnings (or losses). In this way, day traders are actively and aggressively pursuing their own investment beliefs and strategies with the belief that their experience, knowledge and timing will provide better results.
Advantages of Active Investment Strategies
The obvious advantage is that active traders will find and capture investment earnings that are superior to the market.
Active investing also allows investors to make use of short-term trading opportunities, among other, more sophisticated trading tactics.
Disadvantages of Active Investment Strategies
Because active trading requires transactions, an active trader ends up paying much more in fees. This applies whether the investor is parking their portfolio with a portfolio manager—who does all the decision-making and active trading—or the active trader is personally executing the investment trades. These fees can really add up and eat into overall earnings, so active traders need to really pay attention to fees.
Another disadvantage is that active trading usually triggers more tax events. Every time you sell an investment, there is either a loss or gain—and the tax authorities want their cut. While their are ways for active traders to minimize the taxes paid due to their earnings, it is a disadvantage as it requires another level of investing knowledge to avoid paying out a large percentage of your hard-won earnings in taxes.
How to Invest Using Value Investing
This investment technique entails selecting stocks that seem to be trading at a lower price than their fundamental or book value. Value investors aggressively seek out companies, sectors or funds that, they believe, the market is undervaluing and then invest heavily.
One of the most famous value investors is Warrent Buffet—who is famous for never taking a position (buying into a company) without doing a lot of research to understand how it works, it’s position in the overall marketplace, and it’s potential for future growth.
Advantages of Value Investing
This method of investing means that value investors can ignore market noise—the headlines about what’s hot and what’s not. Instead, they focus on analyzing the numbers—price to earnings ratio (P/E), price to book earnings (P/B) or other key metrics that help them assess good quality companies that are not, yet, valued by the market accurately or fairly
One significant advantage of value investing is that investors will often gain significant earnings through the simple principle of buy low and sell high. By finding under-valued stock, the value investor can buy low, wait for the market to notice the company and invest and then sell, for a profit, once the company is valued more reasonably.
Disadvantages of Value Investing
The market can be fickle. While a value investor may notice a company or sector that is prime to grow, the market may remain ignorant or indifferent of this opportunity for a long time. For that reason, value investors need to have a good head (and heart) for risk and not buy or sell based on emotion or impulse.
How to Invest Using Growth Investing
Growth investors often invest in growth stocks, which are new or tiny businesses whose profits are predicted to rise at a faster rate than their industry sector or the broader market. Many investors find this investment appealing since buying shares in new firms may yield large profits if the company is successful.
Advantages of Growth Investing
Investors in growth must be able to accept volatility. You will require a solid grasp of both the firm and the marketplace in which the company operates, as well as market mood and crowd psychology.
Disadvantages of Growth Investing
It is possible to earn much bigger returns, but this is not guaranteed. If you invest in a firm that does not grow, you may end up with less than you originally invested.
How to Use Income Investing
When you invest for income, your money works for you and pays you on a regular basis. Securities and assets such as return on capital (ROC) stocks, bond rates, dividend payouts, and interest payments can all be used to generate income and used as an income-investing strategy. Another option is to purchase rental properties, or property investment funds known as REITs. No matter what type of investment or earnings, the overall purpose of income investing is to produce regular cash flow for the investor.
Advantages of Income Investing Strategies
The obvious advantage of income investing is that the investor receives regular income—payouts—from this investment portfolio.
Disadvantages of Income Investing Strategies
Income investing also has disadvantages, including potential tax, lower potential total returns, increased interest-rate sensitivity, lost purchasing power from inflation, low-interest rates, and stagnate yields.
How to Invest Using Indexing
Economists, market analysts, and investors generally pay attention to the critical indices’ in the market. Indices—plural for an index—is a basket of holdings that is created in an effort to monitor and match market performance. The overall aim of an index is to track past and current sector or industry performance in an effort to make better educated decisions about future earnings.
As an investment strategy, index investing is a passive strategy that involves purchasing (investing in) an index fund—a fund that captures the entire market. By investing in an index, an index investor accepts that the market is going to dictate the ups, downs and earnings for the portfolio.
Advantages of Index Investing
Low cost, little financial expertise, simplicity, and diversity are some of the advantages of index investing.
Disadvantages of Index Investing
The disadvantages of index investing include the absence of downside protection, the lack of flexibility in index composition, and the inability to outperform the market.
How to Invest Using Dividend Growth Investing
Dividend growth investing is a strategy in which you invest in a companies that experience consistent year-over-year growth, cover costs and generate cash flow. These companies use their growth to entice potential investors to invest by paying out a portion of the earnings back to the investor. This payout is known as a dividend and companies that pay dividends can choose to do it in an ad-hoc fashion or on a regular basis, such as monthly, quarterly or annually.
Advantages of Growth Investment Strategies
One of the many advantages of investing based on dividends is that dividends can provide a reliable income stream that can be more tax-efficient than other income-producing investment strategies.
Dividend investment strategies are also advantageous because many will allow the investor to capture reinvestment opportunities—the earned dividend is automatically reinvested back into the company, thereby increasing the investors share of the company and increasing their overall dividend earnings.
Disadvantages of Growth Investment Strategies
However, there are some disadvantages tied to this method of investing. One downside of dividend growth investing is the deteriorating potential for massive profits, disconnection between dividends and business growth, and high yield dividend traps.
How to Use Contrarian Investing
Contrarian investing is a method for profiting from deals that go against prevailing market opinion. If the market is bullish, the contrarian investor will be bearish and hunt for ways to sell. On the other hand, if the market is bearish, the contrarian is optimistic and will seek opportunities to purchase.
Advantages of Contrarian Investing
Investing in the other direction may be a rewarding experience. Typically, the market exaggerates events that influence stock values. A reasonable investor who adheres to the contrarian investment concept can take advantage of the circumstance and profit handsomely.
Disadvantages of Contrarian Investing
There may be moments when a stock’s crowd dumping is justified. There might be specific details concerning predicted sales declines or significant margin pressure. Following a contrarian investment strategy blindly might backfire in such situations.
