Investing in equities isn’t just a matter of deciding which shares or funds to buy and which markets to buy them in. Investors, professional or otherwise, will typically have their own style, strategy and long-term goals which will underpin their decisions.
We examine five of the most popular.
- The five most common investment strategies.
- What they aim to achieve.
- What to look out for with each approach.
Some investors may focus on buying shares that appear cheap, hoping to profit if the share price rallies. Others prefer to choose stocks that are already rising, in the hope of further gains.
Deciding on a suitable strategy can depend on various factors, including your financial goals, time horizon and risk appetite. And while some investors adhere to one particular strategy, many use several different strategies over time. And investment strategies, like clothes, tend to go in and out of style depending on the conditions in the wider market.
It’s important to remember that no investment strategy is likely to produce market-beating returns year after year and none are immune from the risk of losing money.
The value of investments can fall as well as rise and you could get back less than you invest. If you’re not sure about investing, seek independent advice.
Being aware of different potential strategies is useful for those who hold funds run by a fund manager, as it may be better to pick managers with a range of strategies as part of a portfolio of funds, creating a more diversified portfolio.
Here’s an overview of the five common approaches to stock picking.
Growth investors concentrate on companies that are expanding rapidly and posting strong profit growth. They’ll look for features such as a solid history of earnings growth, expanding revenues and profit margins, regular positive profit surprises, or a long run of analyst earnings upgrades. These companies will also often reinvest their profits in the business rather than pay an income to investors in the form of a dividend.
Because investors are often impressed with strong earnings growth and expect it to continue, growth stocks can trade at high valuations. But this can potentially make them especially vulnerable to setbacks if sentiment sours. Investors piled into high-growth technology stocks in the technology bubble of the late 1990s. But many were left nursing severe loses when the bubble eventually burst.
While value investors seek out gems the crowd has overlooked, momentum investors are the crowd. They buy stocks that have already gone up on the assumption that they can keep doing so. Advocates point to the ‘momentum effect’ – the tendency for stocks to continue trending in the same direction for several months.
It can be a highly successful strategy. Trends or fashions, no matter how unjustified they seem, can keep going for far longer than you might expect.
Sometimes sectors or markets can keep rising for years. Or as John Maynard Keynes put it “The market can stay irrational for longer than you can remain solvent.”
The risk, of course, is that fashions can abruptly change, and in such a scenario, momentum investors can be left exposed to the full force of a market correction.
While growth investors opt for fashionable companies, value investors do the opposite, they seek out bargains others have missed. They look for firms that are trading at a discount to their true value.
Value investors stand to gain if other investors decide that they overlooked a bargain and bid up the price.
The problem is that shares are often cheap for good reason. Just because a company’s share price is low, it doesn’t make it cheap. The company might be going through financial difficulties, or losing market share to a rival.
While the rewards can be huge, buying low and selling high isn’t nearly as easy as it sounds. Remember when it comes to value investing, you may never get the opportunity to ‘sell high’, as your investments could easily remain stuck in the doldrums.
Being contrarian involves going against the consensus. While we all like to think we’re capable of defying the crowd, the instinct to follow the herd is powerful. Adopting a contrarian stance requires an abundance of patience because essentially you’re waiting for a catalyst to turn around the fortune of your chosen investments – this could take a significant amount of time – and there’s no guarantee it’ll happen at all.
In the mid-1990s, some contrarian investors thought stock markets were too expensive and due for a fall. Markets were historically overpriced, but they just kept going up.
Being contrarian for its own sake is no use. Sometimes when people talk about being contrarian, they actually mean value investing. That’s going against the herd to seek out value and being strong enough to keep your nerve if things go against you before your strategy eventually pays off.
Income investors tend to focus on dividend paying shares – firms that distribute their profits to their shareholders rather than retaining it within the company . Dividends typically come from large, mature firms in industries that are no longer rapidly expanding.
Dividend yields are the dividend payout per share expressed as a percentage of the share price.
Income investing is seen as a relatively low-risk strategy as it focuses on locking in income and doesn’t so much depend on capital gains. As high dividend yields can be a sign that a stock is undervalued, income investing is often deemed a form of value investing.
It’s important to bear in mind that it takes a certain level of skill, knowledge and experience to successfully follow any of these strategies. Even then, following one of these strategies is no guarantee of success.
In any case, always remember that past performance is no indication of future returns. The value of your investments and any income from them may fall as well as rise, so you could lose money.
For most investors, and certainly novices, looking to invest in growth stock fund can be a good starting point. When you invest in a fund, your and other investors’ cash is pooled together, and managed by a professional fund manager, who will pick and choose assets on your behalf. Funds typically have a wide spread of investments which helps to diversify risk. For example a UK growth fund will generally have investments across a range of stocks from a wide variety of different British industries.
There is a huge selection of funds to choose from, and each one has its own objective. Some will invest exclusively in UK blue chip companies, while others might focus on the US or Europe. In many cases, funds consist of a single asset type, such as either shares or bonds but others, namely multi-asset funds, invest in a wide variety of different assets including shares, bonds, cash and sometimes commodities.