There are plenty of approaches to investing in the stock market. Some strategies may appeal to you more than others, and each has its own strengths and weaknesses. Concentrating on one or two strategies will allow you to develop the skill and experience to maximise returns. In this post we outline some of the most popular investment strategies. We also discuss the issues to consider when finding the approach that is right for you.
- What is an investment strategy?
- Investing best practices
- 12 Popular Investment Strategies
- How to choose your personal investment strategy
What is an investment strategy?
Investment strategies are consistent and methodical approaches to investing. They guide investing decisions according to a set of criteria or according to a theme. Investing strategies can provide discipline and method to your investing activities. They also give you a way to measure or compare your investment returns. Without a strategy it’s very difficult to set investment goals, let along know if you are achieving them.
Investment strategies all have strengths and weaknesses, which allows you to evaluate and compare them. This helps when deciding on the right investment strategy given your financial situation, knowledge, and goals.
Investing best practices
Before we outline the most common investing strategies, it’s worth covering a few principles that apply to all investing. Firstly, you should never rush into an investment – even, and especially, for fear of missing out. Making investments that aren’t carefully considered usually ends badly. Smart investments are very seldom the ones that everyone is rushing into or talking about.
Secondly, stick to what you understand. If you don’t understand an investing strategy, either avoid it or learn about it. The same applies to stock picking. Avoid companies you do not understand, and especially companies with business models that don’t make sense to you.
You should also be realistic with your expectations. The best investors in the world don’t earn more than 20 to 25% a year consistently. Start out with modest goals and build your confidence and skills. The more you diversify your investments; the less damage one or two bad decisions can have. A diversified portfolio will also be less vulnerable to a bear market.
12 Popular Investment Strategies
- Buy and Hold Investing
- Growth Investing
- Momentum Investing
- Value Investing
- Small Cap Investing
- Dividend Investing
- ESG Investing
- Factor Investing
- Passive Investing
- Core / Satellite Approach
- Long / Short Strategies
- Multi Asset Investing
1. Buy and Hold Investing
The simplest long-term investment strategy is buy and hold investing. Individual stocks are simply bought and held indefinitely. How well a buy and hold portfolio performs will obviously depend on the companies that are held. Although buy and holding is the simplest of investment strategies, it can be more effective than one might assume. Investors are often their own worst enemies and frequently sell their investments at the wrong time. This approach removes that problem for the equation.
There are two ways you can vastly improve the probability of success for a buy and hold portfolio. Firstly, look for stocks that are likely to be around for a long time. Stocks with a strong brand that are not likely to be disrupted are a good option. Secondly, keep your positions small. That way the picks you get wrong won’t do too much damage to your portfolio. And, the stocks that do very well will grow into substantial positions in your portfolio.
2. Growth Investing
The biggest advantage of growth investment strategies is that they give you exposure to the fastest growing sectors and industries. This means you are allocating capital to companies with the best chance of generating high annual returns. Investing in growth stocks is also exciting, and you get to learn about the companies that are innovating and creating the future. However, growth investing should be approached with caution.
Growth stocks typically have the highest valuations in the market. They need to live up to the market’s expectations to justify their valuations, or the stock price will correct – often very dramatically. If you are investing in growth stocks you need to do your homework and avoid chasing companies that are based on sentiment alone.
3. Momentum Investing
Momentum investing is similar to growth investing but considers the stock’s price momentum rather than earnings or revenue growth. Evidence suggests that the top performing stocks during a given period have a high probability of outperforming during subsequent periods.
Buying and selling decisions are therefore made using price action alone, though it helps to avoid small and illiquid companies. A very simple momentum strategy would invest in 10 to 20 top performing stocks and hold them for 12 months. At this point all stocks are sold and the process is repeated. More complex variations of the strategy will continuously rotate capital into stock with the highest momentum on a monthly or quarterly basis.
Momentum investing tends to generate good returns most of the time, but occasional losses can be considerable. It is best to include other methods alongside momentum investment strategies.
4. Value Investing
Value investing has produced the most consistent long-term returns over the last 100 years. Warren Buffett made his fortune investing in companies with reliable earnings at attractive prices. Value investors buy stocks trading at or below their intrinsic or fair value. This provides a margin of safety when the unexpected happens. The lower the valuation is when a stock is purchased, the less the company has to earn to generate a decent return in the future.
Value investors must understand financial statements to determine the true value of a company. Most cheap stocks are cheap for a reason. A value investor’s job is to identify the high quality, cheap stocks.
5. Small Cap Investing
There are two advantages to focussing on smaller companies. Firstly, it easier for a small company to grow its profits. Doubling revenue from a base level of $100 million is a lot easier than it is from a base level of $10 billion. Secondly, smaller companies are more likely to be overlooked by investors and therefore trading at a discount. As the company grows, other investors take notice and the discount will narrow. This can provide an additional return if you are an early investor.
There are a few challenges to investing in small cap stocks. Information is harder to find, and you will need to spend more time on research. Small companies are also less liquid and their share prices are more volatile. You will need to manage risk carefully and avoid situations where liquidity evaporates before you can exit.
6. Dividend Investing
The objective of dividend investing, also known as income investing or yield investing, is to generate an income stream. Stocks with high dividend yields are usually very profitable but have relatively low growth rates. As a dividend investor, your job is to find companies with good yield that will be able to continue paying dividends. If the company is able to increase its dividend yield, that’s even better.
Dividend investment strategies are not just about generating income. If dividends are reinvested, a yield portfolio can experience substantial capital growth too. Companies that pay dividends are typically quite profitable and therefore also defensive during recessions.
7. ESG Investing
ESG investing considers the effect of environmental, social and governance factors on the long-term value of a company. The rationale is that companies that take governance and their environment seriously, are more likely to succeed. ESG investing is similar to SRI (socially responsible investing), impact investing and ethical investment strategies. However, these approaches seek to restrict the way capital is used. ESG investing looks at the way similar issues affect returns.
Individual investors can invest in ESG funds or use ESG rating services to do their own stock picking. The field is still new, and the effectiveness of these strategies has not been proven. It’s advisable to do some due diligence before investing in a fund or subscribing to a ratings service.
8. Factor Investing
Factor investing is an evidence-based approach to selecting stocks. Investment factors are characteristics of stocks that have been proven to outperform over long periods. Many of the most commonly used factors are those covered above – value, growth, market value and momentum. Other commonly cited factors include volatility and quality. In the case of factor investing, these concepts are reduced to metrics that can be quantified.
Several quantitative investing firms have launched ETFs (exchange traded funds) that use factors to index stocks. These products allow advisors, and even individual investors, to construct portfolios based on empirical evidence rather than theory.
9. Passive Investing
Passive investing, or indexing, is a variation of buy and hold investing. However, investments are made in indices rather than individual stocks. There are several advantages to this approach. Firstly, investing in market cap weighted indices means you will be invested in the fastest growing, large cap stocks in a stock market.
This eliminates the need to select stocks and ensures you will hold all the significant stocks. Passive investing is most commonly implemented with ETFs, which charge very low fees relative to other products. You only need to pay commission on a single transaction to own dozens if not hundreds of stocks.
Research has shown that most actively managed mutual funds fail to beat their benchmark. Passive ETF investing allows you both to track the benchmark and pay lower fees. The amount saved on fees compounds over time just like compound interest. This fact alone can result in significantly higher returns in the long run. Just like the buy and hold approach, passive investment strategies prevent investors sabotaging their returns by selling at the wrong time.
10. Core / Satellite Approach
The core satellite approach to investing combines passive and active investing. A core portfolio of exchange traded funds is held along with a handful of actively managed investments. This allows a fund manager, or investor, to take advantage of occasional opportunities that will be missed by index funds. For example, individual stocks can be bought or sold when valuations are extreme, and investment can be made in exceptional, smaller companies.
Core satellite / portfolios typically allocate about 70% to passive funds with the remainder being allocated to active strategies. The active portion of the fund can be allocated according to any of the strategies discussed above.
11. Long / Short Strategies
Short selling is one of the only ways to capture downside returns. This doesn’t only allow one to profit from a stock market crash. Combining long and short positions reduces market risk in a portfolio. Returns can be generated from the relative performance of two instruments, regardless of the direction they are moving.
Market neutral hedge funds use long / short strategies to do just this. They generate returns with little correlation to the market and can be used to reduce the volatility of a larger portfolio. Catana Capital’s Data Intelligence Fund uses long / short investment strategies based on market sentiment. User generated data is gathered from hundreds of sources. Artificial intelligence is then used to measure market sentiment and find tradeable patterns using this data.
12. Multi Asset Investing
Stocks typically generate the highest returns over the long term. However, they are also the most volatile asset class. Superior risk adjusted returns can be generated by combining several asset classes. The more asset classes there are in an investment portfolio, the lower the volatility and portfolio risk will be. A very diversified portfolio may include stocks, bonds, cash, commodities, real estate, hedge funds and private equity funds. Diversification can be increased further by spreading the stock portfolio across several of the investing strategies listed above.
How to choose your personal investment strategy
There are several things to consider when choosing the best investment strategy for you. For a start, the approach should interest you. You will be more likely to learn and do the required research if you find an approach interesting.
Secondly, your own skills and experience can give you a head start in some areas. For example, value investors need to understand financial statements. If you have knowledge of certain industries, this can also be an advantage. If you can write code, you may gravitate toward momentum investing and develop your own algorithm.
Another important factor to consider is the time you have to devote to investing. Value, growth, and small cap investing requires a lot of time to do the necessary research. On the other hand, momentum and passive investing require very little time. Finally, your risk tolerance needs to be considered. This concerns both your financial situation and your temperament. If a volatile investment is going to keep you awake at night, passive investing or a portfolio with broad asset allocation will be more appropriate.
Conclusion: Choose the best investment strategies for you
Finding and focussing on investing strategies that resonate with you will allow you to become an expert and develop your own effective investing process. Most successful investors have taken these types of strategies and made them their own by drawing from their own experience and research. As a retail investor you have the advantage of size and flexibility. You can build on this edge by developing your own unique strategy by building on one or two of these investing methods.