All investing strategies have one goal in common: maximizing returns while minimizing risk. The best strategies should help you meet your financial goals and grow your wealth while maintaining a level of risk that lets you sleep at night. The investment strategy you choose may influence everything from what types of assets you have to how you approach buying and selling those assets.
There is no "one size fits all" when it comes to the best investment strategy. But it's one of the questions I receive almost every day.
From what do I invest in, to how to get started investing, to picking individual stocks, everyone is looking for a magic investment strategy that will make them millionaires overnight.
The truth is that doesn't happen. You invest in stocks because over the long run, investing in the stock market has outperformed other investments. But that doesn't mean you should invest everything in stocks.
Here's how to craft the best investment strategy and why you should always think about your portfolio and all your money as a whole. While we call this the investment strategy by age guide - your age is really subject to your investment time horizon.
The two most frequent questions I get from Millennial Money readers are "what do you invest in" and "what are the best investing strategies?" I've received over 300 of those emails in the past month alone.
The best investing strategies are one where you can maximize your return while minimizing your risk, and while you can invest in literally anything, the best investments I've found are stocks, bonds, and real estate.
Below is the investing strategy I've used and still use to this day to build wealth. I've outlined some of these ideas before in my millennial millionaire strategy and millennial money portfolio posts, but this post focuses exclusively on investing.
The best investing strategies are not always the ones that have the greatest historical returns. The best strategies are those that work best for the individual investor's objectives and risk tolerance. In different words, investing strategies are like food diets: The best strategy is the one that works best for you.
Also, you don't want to implement an investment strategy and find that you want to abandon it for some hot new trend you discovered online. Don't get confused by all of the too-good-to-be-true flavours of the month. Stick to the time-tested basics.
To use another familiar metaphor, investing styles and tactics are like the clothes that fit you best. You don't need anything expensive or tailor-made; you need something comfortable that will last a long time, especially if your investment objective is long-term (10 years or more).
So before committing to anything, whether it be food diets, clothes, or investment strategies, see which works best for your personality and style. You can start by considering the top five investing strategies which are shown below, some of which are theories, styles or tactics, which can help you build a portfolio of mutual funds or ETFs.
The Importance of Defining Your Investment Strategy
Having an investment strategy is like having an instruction booklet guiding you through the investment process. It will help you discard many potential investments that may perform poorly over time or that are not right for the investment goals you are looking to achieve.
When creating an investment strategy, it is essential to figure out what you are seeking to accomplish quantitatively. Stating that you simply want to make money or become wealthy is not helpful. A better objective would be to say "I want to achieve an 8% average annual return on my investment contributions over the next 10 years to amass $200,000 that will be used to purchase a cottage home." The more specific the objective, the better. And it doesn't stop there. An investment strategy is useless without a proper understanding of it. DIY.FUND helps you design your portfolio and oversee your investments to understand better and manage them. Many different strategies apply to different investment objectives; the key is pairing the right strategy with the right objective.
Once you have gained some familiarity with the stock market terminology and are ready to take the next step, we have found this one newsletter is the best for beginner investors to get the best stock picks that have beat the market consistently over the last 5 years.
What Is an Investment Strategy?
An investment strategy is what guides an investor's decisions based on goals, risk tolerance, and future capital needs. Some investment strategies seek rapid growth where an investor focuses on capital appreciation, or they can follow a low-risk strategy where the focus is on wealth protection.
Understanding Investment Strategies
Many investors buy low-cost, diversified index funds, use dollar-cost averaging, and reinvest dividends. Dollar-cost averaging is an investment strategy where a fixed dollar amount of stocks or a particular investment is acquired on a regular schedule regardless of the cost or share price. The investor purchases more shares when prices are low and fewer shares when prices are high. Over time, some investments will do better than others, and the return averages out over time.
Some experienced investors select individual stocks and build a portfolio based on individual firm analysis with predictions on share price movements.
It's always nice when things have a clear label, and you can't get much clearer than "buy-and-hold." Buy-and-hold strategists seek investments they believe will perform well over many years. The idea is not to get rattled when the market dips — or even drops — in the short term, but to hold onto your investments and stay the course. Granted, buy-and-hold only works if investors still believe in their investment's long-term potential through those short-term dips.
This strategy requires investors to carefully evaluate their investments — whether they are broad index funds or a rising young stock — for their long-term growth prospects. But once this initial work is done, holding investments saves time you would have spent trading, and often beats the returns of more-active trading strategies.
Growth investing involves buying shares of emerging companies that appear poised to grow at an above-average pace in the future. Companies like this often offer a unique product or service that competitors can't easily duplicate. While growth stocks are far from a sure thing, their allure is that they can grow in value much faster than established stocks if the underlying business takes off.
New technologies often fall into this category. For example, suppose someone believes that homebuyers are going to shift increasingly from banks to online mortgage lenders with a streamlined application process. In that case, they might invest in the lender that they believe will become dominant in that market.
We begin with growth investing using fundamental analysis because it is one of the oldest and most basic forms of investing styles. Growth Investing is an active investing strategy that involves analyzing financial statements and fundamental factors about the company behind the stock. The idea is to identify a company whose business metrics shows evidence of the potential to grow substantially in the years ahead. This style of investing looks to construct a portfolio of 10 or more individual stocks, rather than selecting an index fund.
It can be considerably time-intensive for a beginner to do enough quality research to be successful at this investing strategy, however this strategy, or a variation of it is the bread-and-butter work that most professional fund managers do to generate returns in their line of work.
Growth stocks typically perform best in the mature stages of a market cycle when the economy is growing at a healthy rate. The growth strategy reflects what corporations, consumers, and investors are all doing simultaneously in healthy economies--gaining increasingly higher expectations of future growth and spending more money to do it. Again, technology companies are good examples here. They are typically valued high but can continue to grow beyond those valuations when the environment is right.
Data from the financial statements is used to compare with past and present data of the particular business or with other companies within the industry. By analyzing the data, the investor may arrive at a reasonable valuation (price) of the specific company's stock and determine if the stock is a good purchase or not.2
Bring Balance Into Your Financial Plan
A quote attributed to Titus Maccius Plautus, a Roman comic playwright, has unexpected relevance for investors: "In everything, the middle course is best: All things in excess bring trouble to men." Balance serves as the ideal metaphor for long-term investing. Needs change over time and shortcut stratagems that may work one year can prove ineffective – and even costly – the next. U.S. News asked experts to weigh in on some of the soundest investing strategies to use throughout your life.
Invest In What You Understand
Ignorance is never bliss when betting on a particular sector or company over time. Otherwise, you may as well play the slots in Las Vegas. "If you don't understand the business you invest in, you're going to be highly unlikely to discern the noise from significant information that should factor into your decision-making," says Thomas Sudyka Jr., president of Lawson Kroeker Investment Management in Omaha, Nebraska. Stay away from investment strategies that are too obscure, complex, or out-of-your-wheelhouse to keep up with. If you don't really know how investments work, how can you expect them to work for you?
Reminder: Investing is Long Term
Investing is not gambling - and investing is long term. If you invest today, could you lose money? Yes. 100%.
If you don't invest in a portfolio of diversified investments, do you increase your risk of losing money? Yes.
If you follow individuals who pick stocks and trade, do they win sometimes? Sure. But so do gamblers in Las Vegas.
If you go back to that table above, investing is long term because you want to take advantage of the long term behaviour of an asset class - you're not betting on the individual behaviour of one company. And to achieve that result, you need to stay in the market for a long period of time.
There is no way to predict what will happen tomorrow, next week, or next year. But over the long term (decades), we can extrapolate some historical data to build an estimate of what usually works.
That's why you consistently will hear me (and most other financial planners) say that you need to invest in index funds over the long term.
Sectors Likely to Outperform the Market. Over most of the past decade, the action in stocks has been in the S&P 500. Few if any sectors have outperformed the index, resulting in a concentration of investor funds in this single asset class. But just because the S&P 500 has been providing reliable returns doesn't mean there can't or won't be a change in market leadership.
Subtle changes in the forces driving the market may be setting up a new dynamic. And it's generally true that flat or declining markets tend to favour individual stock or sectors. That's become something of a lost art in recent years, as investors have been richly and consistently rewarded simply by investing in the S&P 500.
But there may be signs that's about to change.
"Investors should expect significant performance divergence among the sectors of the S&P," says Forbes contributor, Oliver Porsche. "Rate sensitive sectors such as utilities, consumer staples, communication services and financials will outperform their more cyclical counterparts."
Other sectors worth investigating include healthcare and energy. Healthcare tends to perform well despite volatility in the general stock market. Meanwhile, energy has the potential to outperform the market due to international disturbances in supply. If the current war of words between the U.S. and Iran erupts into a hot war, energy prices would be almost certain to spike.
Another major sector is foreign, emerging markets. "The reality is that international stocks, whether they be emerging markets such as China, Eastern Europe or Latin America (or a developed overseas market such as Japan's) are compellingly undervalued, while U.S. stocks are precariously overvalued," says Forbes contributor, James Berman. "International stocks are undervalued to roughly the same extent that U.S. stocks are overvalued."
It may be time to begin loading up on foreign stocks.
Value investors are bargain shoppers. They seek stocks they believe are undervalued. They look for stocks with prices they believe don't fully reflect the intrinsic value of the security. Value investing is predicated, in part, on the idea that some degree of irrationality exists in the market. This irrationality, in theory, presents opportunities to get a stock at a discounted price and make money from it.
It's not necessary for value investors to comb through volumes of financial data to find deals. Thousands of value mutual funds give investors the chance to own a basket of stocks thought to be undervalued. The Russell 1000 Value Index, for example, is a popular benchmark for value investors and several mutual funds mimic this index.
As discussed above, investors can change strategies anytime but doing so—especially as a value investor—can be costly. Despite this, many investors give up on the strategy after a few poor-performing years. In 2014, Wall Street Journal reporter Jason Zweig explained, "Over the decade ended December 31, value funds specializing in large stocks returned an average of 6.7% annually. But the typical investor in those funds earned just 5.5% annually." 1 Why did this happen? Because too many investors decided to pull their money out and run. The lesson here is that in order to make value investing work, you must play the long game.
Warren Buffet: The Ultimate Value Investor
But if you are a true value investor, you don't need anyone to convince you to need to stay in it for the long run because this strategy is designed around the idea that one should buy businesses—not stocks. That means the investor must consider the big picture, not a temporary knockout performance. People often cite legendary investor Warren Buffet as the epitome of a value investor. He does his homework—sometimes for years. But when he's ready, he goes all in and is committed for the long-term.
Consider Buffett's words when he made a substantial investment in the airline industry. He explained that airlines "had a bad first century." Then he said, "And they got a bad century out of the way, I hope." 2 This thinking exemplifies much of the value investing approach. Choices are based on decades of trends and with decades of future performance in mind.
An investment strategy made popular by Warren Buffet, the principle behind value investing is simple: buy stocks that are cheaper than they should be. Finding stocks that are under-priced takes a lot of research on the fundamentals of the underlying companies. And once you've found them, it may take a few months or years for their price to rise. This buys and holds technique requires a patient investor who wants to keep their money invested for a few years. While the stock market has returned about 8% per year over the last 100 years, there are a few people like Warren Buffet whose stock picks have significantly outperformed the market. If you are planning on keeping your money invested in the stock market for a few years and you want the best source for excellent "value stock" recommendations read this review of the most famous value investing newsletter. All investors should understand at least the basics of value investing.
Made famous by illustrious investors like Warren Buffett, value investing is the bargain shopping of investment strategies. By purchasing what they believe to be undervalued stocks with strong long-term prospects, value investors aim to reap the rewards when the companies achieve their true potential in the years ahead. Value investing usually requires a pretty active hand, someone who is willing to watch the market and news for clues on which stocks are undervalued at any given time.
Think about it like this: A value investor might scoop up shares of a historically successful car company when its stock price drops following the release of an awful new model, so long as the investor feels the new model was a fluke and that the company will bounce back over time.
Active trading is very difficult. Less than five percent of those who attempt it have any reasonable measure of success at it, and less than 1% of traders manage to have stellar returns, but those who do manage to achieve such returns can make a tremendous amount of money. The tool most frequently applied in active trading is some form of technical analysis. This research tool focuses on the changes in the price of the stock, rather than in the measurements associated with the underlying business. As such, traders can profit from much shorter-term moves and have the opportunity to employ leverage with their strategies.2
Traders can work on any time frame from months, to days to minutes or even seconds. They often use price data from exchange feeds or from charting platforms to recognize recent price patterns and correlated market trends. They use these in an attempt to predict future price movements. Since no indication is infallible, a trader must establish parameters for acceptable levels of risk, reward and win-loss rates for their trading. While the technical analysis may be the primary tool for active traders, and fundamental analysis may be the primary tool for growth investors, proponents of both camps make use of both tools on frequent occasions.
A slower-paced version of active trading that is more acceptable to professional money managers may be employed in specialty funds and by individual investors as well. This strategy is known as momentum investing. The strategy acknowledges that even in random price movement trends manifest themselves and are capable of being capitalized. Longer-term investments intended to last several months may be initiated with the expectation that momentum will continue to build, and the price will continue in the same direction. Most commonly, and especially with mutual funds designed to capture the momentum investing strategy, the idea is to "buy high and sell higher." For example, a mutual fund manager may seek growth stocks that have shown trends for consistent appreciation in price with the expectation that the rising price trends will continue.
Momentum investors ride the wave. They believe winners keep winning and losers keep losing. They look to buy stocks experiencing an uptrend. Because they believe losers continue to drop, they may choose to short-sell those securities. But short-selling is an exceedingly risky practice. More on that later.
Think of momentum investors as technical analysts. This means they use a strictly data-driven approach to trading and look for patterns at stock prices to guide their purchasing decisions. In essence, momentum investors act in defiance of the efficient-market hypothesis (EMH). This hypothesis states that asset prices fully reflect all information available to the public. It's difficult to believe this statement and be a momentum investor given that the strategy seeks to capitalize on undervalued and overvalued equities.
Does it Work?
As is the case with so many other investing styles, the answer is complicated. Let's take a closer look.
Rob Arnott, chairman, and founder of Research Affiliates, researched this question, and this is what he found. "No U.S. mutual fund with 'momentum' in its name has, since its inception, outperformed their benchmark net of fees and expenses."
Interestingly, Arnott's research also showed that simulated portfolios that put a theoretical momentum investing strategy to work actually "add remarkable value, in most periods and most asset classes." 8 However, when used in a real-world scenario, the results are poor. Why? In two words: trading costs. All of that buying and selling stirs up a lot of brokerage and commission fees.
Traders who adhere to a momentum strategy need to be at the switch and ready to buy and sell at all times. Profits build over months, not years. This is in contrast to simple buy-and-hold strategies that take a set-it-and-forget-it approach.
For those who take lunch breaks or simply don't have an interest in watching the market every day, there are momentum style exchange-traded funds (ETFs). These shares give an investor access to a basket of stocks deemed to be characteristic of momentum securities.