An investment strategy is a set of rules – your game plan or style of investing, if you will – that guide how you pick your investments. There are many types of investment strategies, but here are some designed to help you build a portfolio that fits your risk tolerance and financial goals.
An investment strategy aims to minimize risks while maximizing potential returns. However, remember that short-term losses are possible when investing in market-based securities like stocks and bonds. Effective investment strategies typically require time to yield results and should not be viewed as “get rich quick” schemes. Therefore, start investing with realistic expectations about what you can and cannot achieve.
Investing well can help you build wealth, create a powerful income stream, and fund your retirement – but to achieve those goals as planned, without adding undue risk, you need the right strategy, the best investments, and time.
Poor investment choices, on the other hand, lead to underwhelming results. And it matters.
Popular Investment Strategies
1. Growth investing
A growth investing approach is focused on picking stocks with higher growth potential compared to their industry or the market as a whole.
This strategy is well-suited for buying young or small companies but can be applied to larger companies with continued growth characteristics as well.
2. Value investing
A value investing strategy focuses on companies that investors believe are trading at a discount to the value of their assets or earnings.
Essentially, the stock price of the company is believed to be lower than it should be.
3. Income investing
An income investing strategy emphasizes investments that produce regular income rather than relying solely on increases in asset value.
Such a portfolio may consist of dividend stocks, bonds, cash equivalent accounts, and some real estate.
4. Diversification
Diversification is a basic investment principle designed to reduce the risk of any single investment or type of investment causing undue damage to a portfolio.
Diversification is achieved by owning a mix of asset classes (stocks, bonds, cash equivalents, etc.) and a variety of investments within each asset class.
Typically, investors can diversify easily by investing in mutual funds and ETFs.
5. Asset allocation
As noted above, owning multiple asset classes helps diversify a portfolio. The mix of different asset classes – known as asset allocation – can be managed in a variety of different ways.
- Passive asset allocation sets one mix and sticks to it at all times.
- Active allocation can vary the mix depending on market conditions.
- Target-date allocation sets an asset mix based on the investor’s planned retirement date, and then adjusts that allocation (becoming more conservative) as that date comes closer.
Where to Invest Money?
Investors have thousands of investment options from which to choose these days, but they fall into these major categories:
| Categories | Investment Options |
|---|---|
| Stocks | Individual stock shares Stock mutual funds Stock ETFs Index funds S&P 500 index funds Dividend stock funds Nasdaq 100 index funds International stocks Small-cap stocks |
| Bonds | Treasury securities Government bonds Short-term corporate bonds Long-term corporate bonds High-yield bonds Municipal bond funds |
| Cash Equivalent Investments | High-yield savings accounts Certificates of deposit (CDs) Money market accounts Money market funds |
| Blended Portfolios | Balanced portfolios Asset allocation portfolios Target-date funds |
| Real Estate | Rental housing Commercial Real Estate REITs |
| Annuities | Fixed annuities Variable annuities |
It’s a good idea to narrow the field and focus on the types of investments you’re most likely to select for your portfolio.
You’ll want to understand how each investment performs and what types of risk it involves so you can make an effective decision – especially if you’re just learning how to invest.
Here’s a brief summary of what you might expect from each of the main investment categories listed above.
Top Investment Strategies for Beginners
Buy & Hold
A buy-and-hold strategy involves purchasing an investment and holding it indefinitely. Ideally, you’ll keep it for at least three to five years, if not longer.
Advantages: This strategy encourages long-term thinking and ownership, avoiding the pitfalls of active trading. Your success hinges on the performance of the underlying business over time. This approach can yield significant returns, potentially earning hundreds of times your initial investment. By committing to never selling, you avoid the hassle of market monitoring and capital gains taxes.
Risks: To succeed, resist the urge to sell during market downturns. Endure potential steep market drops, sometimes over 50%, with individual stocks possibly falling even more. This requires strong resolve.
Buy Index Funds
This strategy involves selecting a desirable stock index and purchasing an index fund based on it. Popular indexes include the S&P 500 and the Nasdaq Composite, providing a diversified investment collection.
Advantages: Index funds offer a straightforward approach with potential for strong returns, especially with a buy-and-hold mentality. They provide a diversified portfolio, reducing risk compared to owning a few stocks. Less time and effort are required for stock analysis, freeing you to enjoy other activities.
Risks: While less risky than individual stocks, index funds still require holding through tough times to achieve long-term market returns, averaging about 10% annually for the S&P 500. You’ll get average market returns, not the returns of top-performing stocks, which even professional investors find challenging to surpass.
Index & a Few
The “index and a few” strategy combines index funds with a few small positions in individual stocks. For example, you might allocate 94% to index funds and 3% each to stocks like Apple and Amazon.
Advantages: This strategy blends the low risk and good returns of index funds with the opportunity to invest in specific stocks. It allows beginners to start analyzing and investing in individual stocks without significant risk.
Risks: As long as individual positions remain small, risks are similar to those of index funds. You’ll generally get market-average returns unless you own many outstanding or poor-performing stocks. Understanding stock analysis is crucial to avoid significant losses.
Income Investing
Income investing focuses on assets that generate cash payouts, such as dividend stocks and bonds. These payouts can be used or reinvested.
Advantages: You can use index funds or income-focused funds for this strategy, avoiding the need to pick individual stocks or bonds. Income investments usually fluctuate less and provide regular cash payouts. High-quality dividend stocks often increase payouts over time, enhancing your passive income.
Risks: Despite lower risk, income stocks can still decline, and individual stocks may cut dividends, resulting in no payout and capital loss. Bond yields may not outpace inflation, reducing purchasing power. Taxes on income in regular brokerage accounts may also be a concern, making retirement accounts like IRAs more attractive for these assets.
Dollar-Cost Averaging
Dollar-cost averaging involves regularly investing a fixed amount, such as $500 monthly or $125 weekly, regardless of market conditions.
Advantages: This method spreads out your buy points, reducing the risk of poor market timing. It establishes a disciplined investing habit, potentially leading to a larger portfolio over time.
Risks: While it mitigates the risk of investing all at once at a high point, it also means missing out on investing all at once at a low point. Therefore, you’re unlikely to achieve the highest possible returns.
What Is Your Risk Tolerance?
Every investment involves an element of risk. You can’t avoid risk altogether, but you can manage it.
Deciding how much risk to accept is a personal decision that takes into account your time horizon and your risk profile.
With so many investment choices, a key to determining which is right for you is getting a handle on what types of risk you’re comfortable with. There are several ways to define risk.
Permanently losing money is an obvious one, but even temporary ups and downs can be damaging depending on how soon you need your money.
Then there’s inflation risk (where your returns don’t keep up with the rate of inflation) and longevity risk (where you might outlive your investments).
So, figuring out your risk tolerance starts with deciding what types of risk you are most sensitive to and how much of that risk you can take.
Since risk is most often defined by how well you can bear changes in the value of your investments, risk tolerance is often described in terms of low, moderate, and high risk.
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AUTHOR: Richard Barrington – Financial Analyst
