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Investment Strategies: Beginners’ Guide

UTC by Oluwapelumi Adejumo · 8 min read
Investment Strategies: Beginners’ Guide
Photo: Depositphotos

There are several types of investment strategies to consider based on goals, risk tolerance, and future needs of capital. In this guide, we will have a deeper look at the most popular one.

When it comes to making investments, a lot of factors are considered before a decision is reached. Some investors may decide to concentrate on buying shares that appear cheap, with the hope that they would make a profit if the share price rallies. Other investors may choose stocks that are already on the rise with the hope of getting more profit. Hence, factors that determine which strategies to adopt when it comes to making an investment include financial goals, tendency to take risks, and time horizon.

What Is An Investment Strategy?

Investment strategies refer to the principles and guidelines designed to help investors attain their financial as well as investment goals. Basically, it is what guides an investor’s decisions based on goals, risk tolerance, as well as future needs of capital.

Investment strategies can differ from conservative (which involves a low-risk strategy where the aim is wealth protection) to highly aggressive strategies (which focuses on seeking rapid growth by leveraging on capital appreciation). Investors are able to utilize these strategies to formulate their own portfolios or do so via a financial professional.

Types of Investment Strategies

There are several types of investment strategies to consider.

  • Growth Investment Strategy

This type of investment strategy is about investing in firms that possess high growth rates. Examples of such companies may include Facebook Inc (NYSE: FB), Google LLC (NASDAQ: GOOGL), Apple Inc (NYSE: AAPL), etc. The growth investment strategy was made popular by Peter Lynch in the later 90s and the aim was to buy shares of companies you know to be valuable, and their future growth can be exploited.

Speaking of pros and cons, the growth investment strategy is long-term in nature and can result in higher returns. Besides, you can continuously transfer capital to stocks with the strongest prospect of growth.

However, a lot of changes have been witnessed in the market since its introduction, and growth companies are hard to come by. In addition, predicting which companies within growth industries would come out on top may be more difficult than predicting high-growth industries.

  • Value Investment Strategy

The value investment strategy is all about purchasing companies when they are put up for sale, and when they are priced far below their original value. When executed properly, investors will get growth from companies as well as small-cap and income investments stocks from stocks that are on sale for a discount, while simultaneously accounting for your value and interests.

Firstly, investors are able to get the highest returns with the lowest amount of risk with a value investment strategy. Secondly, with this type of strategy, you can buy companies when they are put up for sale. That means investors are buying stocks during an economic contraction.

However, with the value investment strategy, you need to be patient, hence it is not for everyone. To be successful with this type of strategy, a lot of education and expertise is required. Failure to acquire the right education can cause investors to lose a lot of money.

  • Indexing Strategy

Indexing strategy is a form of passive investment strategy where investors have the opportunity to construct a portfolio similar to the specific market index.

This strategy not only requires little or no financial knowledge, it also has lower management fees than an actively managed fund due to the passive tracking approach it adopts. However, this strategy lacks downside protection, and investors can not add or remove any holdings.

  • Income Investment Strategy

Income investment strategy involves buying securities that have the capacity to pay dividends. Those into this type of investment strategy believe that they can expect a steady profit on a regular basis. Examples of this include bonds that produce steady income, dividend-paying stocks, and mutual funds based on dividend stocks.

As for advantages, the return with an income investment strategy is decent with minimal risks. If you have a huge capital to start with, you can live off of the interest earned based on dividends instead of betting it on the success of the business.

But the are a couple of cons to think of. Firstly, there is a tendency to focus more on the dividends instead of the value of the underlying company or asset. Secondly, it may take a long time to see a meaningful return when practicing this type of investment strategy. Over a long period of time, investors may see as low as 1-2 percent returns.

  • Passive Investment Strategy

Passive investment strategy involves the buying and holding of securities investors believe they can outperform in the market. In this scenario, investors take the long-term approach and allow the investment to grow. This type of investment is less risky than its active counterpart.

This type of investment strategy guarantees ultra-low fees. It is also transparent in the sense that it is always clear about which assets are index funds.

However, passive investment strategy is limited to a specific index or a set of investments with little to no variance. So no matter what happens in the market, investors are locked into those holdings. In addition, this type of investment strategy has a smaller potential in terms of returns.

  • Dividend Growth Investing

Dividend growth investing involves reinvesting dividends received from companies. In this type of investment strategy, investors are always on the lookout for the companies which pay out dividends on a regular basis and therefore reinvest the dividends in order to get the benefits of compounding.

With this type of investment strategy, investors are paid to wait. That means it provides an ongoing return while investors wait for capital appreciation. Investors are also able to create more streams of income for themselves with this investment strategy.

Meanwhile, dividend growth investing does not factor in non-dividend factors such as brand loyalty, customer retention, etc. This strategy relies heavily on speculation as regards the stability of a company’s growth.

  • Contrarian Strategy

Contrarian investment strategy involves making investments against the market trends. Investors using this strategy invest when the market is falling and sell when it is on the rise.

With this strategy, your portfolio is likely to outperform the market on a long-term basis. Purchasing stocks when they are out of favor creates an air of security to the intrinsic value of the stocks, thereby reducing risks.

However, contrarian requires a lot of know-how because you would need to understand the correlation between price fluctuation and events. Choosing this strategy also requires more than going against the market trend. Hence, understanding mis-pricing is also critical.

  • Dollar-Cost Averaging

This investment strategy involves dividing up the total amount that is set aside to invest across periodic purchases of a target asset with the aim of reducing the impact of volatility on the overall purchase.

Dollar-cost averaging reduces the emotional components owing to the fact that investments are made mechanically. Bad timing is avoided. It prevents a situation where you lose all your money when you invest in a particular investment at once.

However, due to the fact that the market tends to go up over time, using this strategy means that you wouldn’t invest a huge sum earlier, which would have done much better than smaller amounts. Further, dollar-cost averaging is not the ideal substitute for identifying good investments. That means it doesn’t cater to all investment risks.

    • Socially Responsible Investing

This type of investment strategy is also known as social investment. It is an investment considered socially responsible as a result of the nature of the business the company conducts. The common feature includes socially conscious investing.

Investors using this strategy can be confident that they are rewarding ethical companies. Socially responsible investing is an opportunity for investors to withhold their money from businesses that are not socially responsible. However, adopting this strategy means you might be passing up many investment opportunities. Sometimes, investors may discover that they have invested in certain companies that claim to be socially responsible but are not.

Choosing The Best Investment Strategy

To choose the best investment strategy, you have to go with the one that suits you the best. So there are several questions you need to answer. What is your investment horizon? What returns are you looking to achieve? What’s your tolerance rate in terms of risks? Answering them correctly will help you in building your portfolio.

The breakdown of your asset allocation will depend on the level at which you are able to tolerate risk. A conservative investor may lean towards holding 80 percent of his portfolio in a fixed-income and 20 percent in stocks. An aggressive investor may choose to go 50-50.

If as an investor you are big in the long term, you may want to focus on growth investing. As an investor with moderate risk tolerance, value and income investing strategies are best. For low-risk-tolerant investors, income investing is more preferable. Socially responsible investing is suitable for investors who are in search of harmless companies.

Conclusion

Investment strategies differ and there is no one-size-fits-all when it comes to making investments. That means you should choose the one who achieves the objectives you set out to achieve as an investor. So you need to re-evaluate your strategies as they get older so as adapt their portfolios to their situation.

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FAQ

What is an investment strategy?

Investment strategy refers to the principles and guidelines designed to help investors attain their financial as well as investment goals.

What are the most common investment strategies?

The most common types of investment strategies include growth investing, income investing, dividend growth investing, indexing investing, value investing, contrarian investing, passive investing, and dollar-cost averaging. 

What is the difference between growth and value investment strategies?

While growth investment strategy seeks companies that offer strong earnings growth, value investment strategy looks out for stocks that appear to be undervalued in the market. 

What is the key feature of contrarian strategy?

The key feature of contrarian strategy is investing against market trends.

How to choose the best investment strategy?

In order to choose the best investment strategy, you need to consider which investment strategy meets your needs. You have to factor in things like risk tolerance, expected returns, financial situations, available capital, etc. 

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