An investment strategy is a defined approach to the investing that shapes the choices an investor makes for his / her portfolio. Different strategies assume specific tactics based on individual fundamental beliefs. For instance, value investing seeks stocks that are undervalued and are selling for less than their true worth, whereas growth investing aims to find investment opportunities in companies that have high potential for growth. Those are just a few of the many investment strategies out there to choose from. This guide will break down the major investment strategies and help you decide which of them is likely to be a good choice for you.
Momentum investing is treated by some as one of the best investing strategy. While buy low and sell high is the mantra we been taught by experts in stock markets, some believe in buying high and selling higher strategy. Investing professionals call it Momentum investing strategy. It is a popular strategy adopted by investors and traders and by adopting this strategy market beating returns can be achieved betting on trending stocks.
If you believe that the trend is your friend in equity market, chances are you are a momentum trader. Momentum occurs when there is relative news hitting public domain. Momentum traders like to jump on the stock, which is moving in one direction, with the hope that the trend will be continued. It is a time tested strategy where there is risk which can be minimised by adopting suitable risk management techniques.
Growth investing is an investment strategy that focuses on building capital through buying equity shares that have the potential to increase in value. This is most commonly found in stocks where investors believe in the value of the company, and thus the value of the shares they’ve purchased, is likely to go up.
Growth investing contains several sub-strategies. Two of the most common are short-term investments and long term investments. Short-term generally means buying stocks and holding them for less than a year. Investors use short-term growth investments when they think a company’s value is likely to shoot up quickly. Long-term investments, on the other hand, are held for more than a year. Investors use these when they believe the company’s value will grow slowly and steadily over the years.
Value investing, an investment strategy championed by Warren Buffett, focuses on seeking out stocks that investor believe are undervalued than its intrinsic value. By finding companies the market does not properly value, investors have the potential to post big gains when the market eventually corrects and the company becomes valued properly. However, this is a very subjective type of investing strategy.
Income investing focuses on generating a steady income from your investments. Rather than seeking stocks that will grow in value and give your portfolio more hypothetical value but make you no richer in terms of cash, income investing wants to find investments where your portfolio sees real-world value in the form of money inflow in your pocket.
Income investments generally made in forms. The first is investment in stocks of companies that pay a percentage of its profits in the form of dividends. That is money flows into your bank account. The other investment common to income investing is bonds, which pay out interest on a consistent basis.
Usually, when equity markets are on a up move, investors are quite happy to join the bandwagon. In fact, in boom times, we seldom discuss the strategy being used by our fund manager because all that matters is that he is giving great returns. It’s only in a downturn that reality checks are done and one looks at strategies to minimise the pain.
One such strategy is a ‘contrarian’ investing. As the name suggests, one would expect the fund manager have a completely different strategy to the existing market conditions.
This basic idea is to protect the downside when markets are falling. But the reverse is also true. Returns in an upside might be lower.
Understanding the term ‘contrarian’ is important here because it can be defined in different ways. In most cases, contra investing involves selection of stocks that are not popular at the moment but has the potential to deliver over time because of factors like strong fundamentals, future turnaround in the cycle and so on.
For contra investing, there are couple of methods are used. The first one is direct investment in stocks, whereby the theme is identified. The stocks are bought, in accordance with the theme and held for a particular time period. The simpler option is to select a contra fund offered by mutual funds to invest in.
While investing in this theme, it’s important to remember that just because a contra approach is being followed it does not imply that there cannot be a fall in the value of the stock or fund in a downturn. Reason for this is that though the fund manager may purchase a stock that is out of favour, the point of entry may not be the lowest one even if they are at historical lows. In that case, the stock would continue to fall for some time.
The most important point to bear in mind of contra investing is that the chances of making money are not immediate. Unlike investment in a bull market, contra investing involves sometimes painfully long time to get good returns.
Obviously, investors in this theme need to be patient. And there is also a risk that expectations are not really met.
But the good part is that when this investment strategy becomes successful, the returns could be extremely high. However, if one looks at the returns of funds in this category and juxtaposes them with returns of equity diversified funds, there is quite a lot of similarity. The similarity in returns is because many contra funds end up investing in same kind of themes because of pressure from investors for positive returns which defeats the very ‘contrarian’ theme.
The contra theme is an interesting one, if one goes by the spirit. However, investors need to look at portfolios more carefully before investing in this theme.
Socially Responsible Investing
The previous investment strategies focus more so on how an investor makes money. This investing strategy is a bit different in that it takes a broader look at how your investing can impact the world at large, beyond your portfolio.
You can tailor a socially responsible investing strategy to what you personally care about when it comes to social responsibility. If you are an environmentalist, for instance, you might invest heavily in green companies and avoid investing in companies that deal in fossil fuels. If you care about foreign policy, you might avoid companies that do business in certain countries.
Choosing an Investment Strategy
There are a number of factors that goes into choosing the investment strategy that will work best for you. One thing is to think about whether you want to choose an active or passive investing strategy. Active investing involves the frequent buying and selling of stocks. It requires hands-on management, often by a portfolio manager who can delve into various factors to forecast the market. Passive strategies, on the other hand, are focused on buying and holding investments for the long haul. Proponents of passive strategies argue this cuts down on trading costs and increases tax efficiency. It also tends to be less risky than market-timing strategies, which can reap big rewards by trying to beat the market but also suffer big losses. Oftentimes, portfolios will blend active and passive investing.
Other factors that you need to consider are your investing time horizon, as such how close you are to the major life goals and events like buying a house, having children or retiring. If you need income soon, you may not want to select long-term investments, for instance. Your risk tolerance is another consideration. Generally, you can tolerate more risk in your early career, and desire less risky, more stable investments as you move towards retirement. A strategy like income investing, which is based on generating a steady income, might be less risky than more subjective strategy like value investing.
The Bottom Line
There is no easy way to pick which investing strategy you should choose when building your own portfolio. You might end up with a mix of sorts. For instance, you might primarily build your portfolio around growth investments, but include some income investments as a way of guaranteeing yourself some more cash you can either use in your everyday life or reinvest to increase your income generation.
The best way to pick an investing strategy is to pick one that can help you to achieve your financial and personal goals.
The writer is a Chartered Financial Analyst (ICFAI).
If you’re wondering what type of investing strategy is right for you or if you simply need help implementing it. You may find it helpful to talk to a financial adviser. It is crucial here to find the right adviser.
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