What is an Investing Strategy
A strategy is plan of action that helps you accomplish a goal or aim so by that logic, an investing strategy can be defined as a plan or action that when followed will help achieve an investing goal.
An investing strategy is what determines an investment decisions based on a number of factors that include how much risk the investor is ready to take and for how long the investor wants to put the money away for.
The goal could be to earn more income for retirement, it could be financial independence and retiring early (FIRE), or being a participant in the market without the headache of constantly looking at what to buy or sell depending on the latest fads.
There are many stocks on the market, many financial instruments and many different geographical regions. Having a strategy will help you maintain focus or at least provide a starting point from which you can begin to explore the rest of the market.
In no particular order, these the main investing strategies.
Dividend Growth Investing
With this strategy as an investor you are looking at stocks that pay dividends and have done so for a significant number of years. This does not mean other factors that indicate the financial health of the company are ignored because if the company fails you can wave goodbye to any dividends.
The main aspect of this strategy is to identify companies that have paid (increasing) dividends over a period of time and add them to your portfolio. As an investor you will add dividend stocks to your portolio because of the income it provides. The dividend it usually paid per share you own.
There are two things to mention when it comes to this investing style and they are the Dividend Yield and the Dividend Payout Ratio.
The dividend yield refers to how much the company will pay out in dividends each year in relation to its stock price whilst the dividend payout ratio is portion of the company’s earnings that is set aside to pay dividends.
For example, a company may choose to set aside 5% of its earning to pay dividends and in this case it should clear to see the more a company earns, the larger the value of the dividend will be so the earnings growth of the company is also an important factor.
Growth Investing
This method of investing requires looking at new industries or sectors, identifying companies that are growing in that space and investing in them.
There is a process in which these companies are identified and a number of factors need to be considered such as market share, earnings, new technology, or anything that will in future allow a company have above average returns in that sector.
The process of identifying potential companies will uncover companies that are undervalued and as time goes on when the value is realised, more interest in the stock will come about when the market realises and this will be reflected in the price
A number of financial ratios such as price to earnings and price to book ration will be used to determine whether or not the company is overpriced and can be useful when identifying stock with potential high growth.
An investor can also consider ETFs in fast growing sectors and passively benefit from that. Notable growth investors include Philip Fisher who is known for his popular book Common Stocks and Uncommon Profit, Peter Lynch and William O’Neil.
Income Investing
As an income investor your goal is to earn an income from your investments and to accomplish that a number of income generating asset classes can be added to your portfolio.
This includes Dividend Stocks, ETFs, Mutual Funds, Real Estate, REITs and Bonds. We have covered aspects of Dividend stocks so will not go into much details here.
Purchasing an investment property and renting it out is one way to earn income on the property as the asset’s value increased. Investing in Real Estate Investment Trusts are yet another way to earn income from property since a large portion of the profit is paid out.
You can earn interest from a Government or Corporate Bond and when the loan term is reached, the initial amount is paid back to the investor. Government bonds are deemed to be less risky so the interest on is lower compared to Corporate bonds.
ETFs or Funds that track dividend paying stocks are also a good addition to a portfolio since the dividend paid by the companies are either put back into the ETF or paid out to the investors. Diversification is also key here because income from one source can be impacted due to tax, low interest rates or other factors which can have an effect on returns.
Momentum Investing
Momentum investors will lean towards market indicators (technical analysis) to determine if and when to purchase an underlying security.
Technical indicators such as moving averages, Relative Strength Index, Trend lines and Average Directional Index are used to determine if there is momentum is growing in the underlying asset class.
The aim here is to use the indicators to identify a trend early, determine the direction and take a position which means to buy or sell the asset. If the outcome of the research suggests the trend is down, momentum investors will sell the underlying asset and if the trend shows an upward trajectory, investors will buy the underlying asset.
Value Investing
As a Value investor you are looking to identify securities that are underpriced and buy them with the aim that the market will catch up with your decision. Value investors will arrive at a decision to purchase a security after carrying out fundamental analysis in an attempt to determine the intrinsic value of the security.
The prominent value investors are Benjamin Graham who is considered the father of value investing since he developed the concept, and Warren Buffett in more modern times. The main metrics used to determine a stock’s value include the price to book ratio, price to earning ratio, free cash flow and debt to equity ratio.
Value investors tend to be contrarian because whilst the market may think the value of a stock is X, the market could be overreacting or underestimating the company so a value investor will tune out the noise, determine the value of the underlying company and make a decision based on the outcome of the analysis.
Passive Investing and Active Investing
Passive and active investing are widely considered to be investing strategies although they differ from the investing strategies listed above. You can read more on active and passive investing on this link here to dig further into what they entail.
Consider an example where, as an investor, you wish to invest in an asset class that provides an income. This is considered as Income Investing. Additionally you choose to purchase ETFs that consists of companies that pay dividends and hold them. This is a passive approach to accomplish that goal.
An active example will be a situation where you do research and find stocks that pay dividends and buy them and earn a dividend from them. You may choose to hold the stocks and if circumstances changes, they can be sold. In some cases, you can also purchase an actively managed fund.
Passive and active investing in this sense refer more to the style in which you choose to execute your strategy. That being said, many investors have put money in recent years in ETFs and Index funds since these provide diversification and a low cost alternative.
Impact Investing
For those investors who are increasingly conscious of what the impact of doing Business is having on the environment and the people in around the business, Impact Investing is a strategy that can provide financial gains whilst preserving the environment.
You can read more on what Impact Investing is here, what the benefits are and how there is increased focus in this space.
Small Cap Investing
Small cap companies depending on the region, are companies whose market cap is between $250million and $3billion. With small cap investing strategy, the aim here is to look for companies that fall within that bracket that have strong earnings, balance sheet and are set to grow. The goal is to identify companies that are growing and invest in them before they go big.
Whilst the risk remain, investing in small caps provides opportunities for investors to potentially discover the next Netflix or Amazon and invest in them. There are indices that can be invested in via ETFs or Index Funds. This way an investor can diversify their portfolio and reduce the risk of having all their investment in a handful of companies.
It is worth nothing small caps can be volatile and for many of these small cap companies, their financial numbers are not readily available to make an investment so an investor will need a bit more research to get information on these companies before deciding on investing.
Buy and Hold
This investment strategy leans towards a passive approach to investing and with this strategy, an investor will purchase an ETF, Index or Stock and hold them for a long period of time whilst disregarding short term price fluctuations.
If you discover a stock that is undervalued after carrying out research and fundamental analysis, an investor may choose to purchase this stock and hold until the value is realised and this can sometimes take a number of years.
This strategy also raises questions regarding active or passive investing and which is superior and there is data to show that sometimes one style would have produced a better return over the other. Read more here about how these styles compare.
That being said, active investing comes with costs such as transaction cost, fund management and research to name a few that passive investing does not have so buying and holding over a long period of time has been shown to provide superior returns due to fewer transaction costs associated with buying and selling the shares or asset class frequently.
What Investment Strategy is Best for Beginners
As a beginner, investing can be overwhelming at first in part due to the vast information and resources that require some time to understand.
No two beginners are the same and these differences are important for example, different ages, income levels, career and other commitments that could determine how an investor may choose to approach investing.
A conservative and less risky approach can be useful for an investor for example as a beginner, where you may choose to adopt a passive strategy that seeks growth. The way you may go about this is putting a large portion of your portfolio in ETFs or Indices that track small caps, high growth companies or companies in new industries.
On the other hand you may choose to get your hands dirty a bit and invest in individual companies in a sector where you have an interest or you have followed macro events closely and realised that a lock down could lead to an increase in Netflix subscribers and other streaming services so you purchase their stocks.
Note the above instances are examples and whilst there is not best strategy for beginners, it is wise to invest a large portion of the portfolio in ETFs and Index funds in order to achieve diversification and exposure to companies in different sectors or regions.
You may wonder what is the best investment strategy or what is the most successful investment strategy? The answer is simple – the one that helps you attain your investment and financial goals hopefully without too much risk.
How do you create an Investment Strategy
With our understanding of what an investment strategy is, the first step in building an investment strategy is outlining what your investments goals are. Is the goal to generate income? Or to get growth in a shorter period of time or to have a more hands off approach to investing.
Once the goal has been established, the next step is to explore the investment strategies mentioned above and apply them. For example if your aim is growth you may choose to focus on small cap stocks, carry out fundamental analysis to identify growth stocks and look further to find undervalued companies and invest in them.
The important thing to remember is that one strategy may not work and multiple strategies may need to be applied at different times depending on market conditions.
Final Note
The examples above outline the main investing strategies and it is important to first seek professional financial advice before making any investments.
The different strategies in the article however provide points you can consider as a new investor or new strategies to adopt if you are not new to investing.
