When you're ready to start investing your money, rather than simply saving it, you should keep in mind that there isn't just one good way to invest. The strategy or style that works for you may not be what works best for your spouse, parent, or best friend.
Asking the right questions can help you decide which path to take when working toward your investment goals. For instance, are you a risk-taker, or are you averse to risk? Are you looking for long-term growth or fast gains? Are you planning to be a do-it-yourself investor, invest through a robo-advisor, or hire an advisor?
This kind of reflection can help you match your needs to your investing style. With that in mind, here are eight ways to invest, each with a special focus.
1. Active Investing
An active investing style might be right for you if you can take more risk and keep a close eye on market trends and movements. Active investing is often used by people who aren't as worried about the long-term horizon as they are with the present. With this strategy, you select certain stocks and use market timing to try to outperform the market to seek short-term profits.
Because active investing involves more frequent and short-term buying and selling, it often comes with vital tax and transaction fee considerations.
One risk to avoid with active investing is trying to chase returns based on things like recency bias, which assumes that a stock's recent performance will continue.
2. Passive Investing
If you are more risk-averse and don't want to stare at the market ups and downs all day, a passive investing style may be more up your alley. Passive investors are those who invest their money with a long-term time horizon. Instead of trying to time the market like an active investor, passive investors create portfolios that track a market-weighted index. Tracking an index will often result in reduced risk due to diversification as well as lower costs due to low turnover.
The growth style of investing is one that takes on stocks of companies whose earnings are growing faster than most other stocks and are expected to grow. These stocks are often looked at as being overvalued and have a high price-to-earnings ratio. It is vital to note that these stocks often pay either a low or no dividend but have the potential to make up for that with strong returns.
Unlike growth investors who seek out overvalued stocks, value investors look for those stocks that are out-of-favor or undervalued. Value investors expect that these securities will rise and seek to buy them before they do. This style has been popularized by Warren Buffett, who argues the merits of buying stocks that sell for less than their value is based on the premise that they'll bring solid returns in the future.
5. Market Capitalization
People who select stocks based on the size of the company are using a market capitalization, or market cap, investing style. Market cap is found by looking at the number of shares outstanding multiplied by earnings per share. There are three broad market cap categories to use in your investing style: small cap, mid cap, and large cap.
Small-cap companies have a market cap of $300 million to $2 billion, mid-cap companies have a market cap of $2 billion to $10 billion, and large-cap companies have a market cap of over $10 billion. Microcaps fall under the $300 million mark, while mega caps are the largest companies by market capitalization.
Small-cap stocks are often riskier investments than large-cap stocks. While their returns may be higher, their volatility is also higher. On the other hand, large-cap firms are those that have been around for a much longer time and tend to be more stable. Many people buy large-cap stocks because of their dividends and stability.
6. Buy and Hold
A buy-and-hold style is an example of passive investing. An investor who does buy-and-hold investing will not trade in their portfolio very often. They are looking for long-term growth. The idea behind buy and hold is that you buy into a stock while its price is still low to benefit from the price going up over time.
Another popular form of passive investing is indexing. With this style, an investor creates a portfolio that mirrors the companies of a particular stock index. They are looking for their portfolio to perform in line with the index. This kind of investing can be good if you want an easy and low-cost way to achieve a diversified portfolio in the long run. Transaction fees and taxes for managing these kinds of portfolios are quite low in large part due to the lower turnover.
Indexing is done by investing in index mutual funds or exchange-traded funds, which track the performance of a benchmark index such as the S&P 500 or the Nasdaq. ETFs tend to be more tax- and cost-efficient compared to traditional index funds.
8. Dividend Growth
For investors nearing or at retirement, a shift from asset growth and capital gains to income may be the right way to go. This way, your investments can produce some of the cash flows you need to live when you're no longer working. Dividend stocks are a common way to achieve this goal. Look for companies with stable and growing dividends.
Which Investing Style Will You Choose?
There is no right or wrong investing style to pursue. The one that ends up working best for you depends on your risk tolerance, the time horizon for investing, age, and investment goals. Remember that your style isn't set in stone either. As you grow older and your investment objectives change, so may your approach.
- When you're ready to start investing your money, you should keep in mind that there is not a "one-size-fits-all" approach. There are at least eight investing styles to consider.
- Active, passive, growth, and value investing are four key strategies.
- Market capitalization, buy-and-hold, indexing, and dividend growth are four other investing styles.