How to Know the Best Way to Invest for Yourself
Choosing investment styles is like matching personality types in relationships. To maximize returns and minimize risk, you need to find the best investment styles and strategies.
Do you like to analyze and research data or do you prefer the "set-it-and-forget it" approach? Do you like to be involved in processes or do you prefer to plant seeds and watch things grow from a distance? Does it take luck or skill (or both) to outperform the major market indexes? Do you find yourself getting excited about gains but anxious about losses? Are you a do-it-yourselfer or might you feel better using an advisor?
These are important questions to ask yourself before committing to an investment style or before trying one on for size, so to speak. Here is a basic overview and checklist of investment styles, tactics, and strategies to do your homework or review before, during and after you invest.
Whether you do it yourself or choose an expert for financial advice, you are choosing an advisor. Start the decision process of hiring an advisor by asking a few reflective questions: If a friend needed an advisor, would you recommend you? Do you want to hire you as the advisor or do you need to hire someone else? What is the value of your time compared to the monetary cost of using an advisor? Do you enjoy the process of investment research and financial planning or do you dread doing it to the point of neglecting your finances?
If you are an index fund investor, you are a person who does not believe that the extra time, energy and trading costs required for the actively-managed portfolio is worth the effort for the chance of out-performing the market. You may even believe that the idea of "beating the market" is a foolish one and you'll likely achieve higher returns with a buy-and-hold strategy. In contrast, the person taking an active approach believes they can make tactical and well-timed moves to achieve superior returns.
An investor can buy stocks of individual companies or buy stocks via the purchase of stock mutual funds. But which one is best? Here are just a few reasons why mutual funds are best for the average investor:
Studies have found that the stocks individuals buy underperform after they buy them and outperform after they sell them. This is primarily attributable to the fact that more than 75% of all traders are institutional, which means that individuals are up against some powerful competition.
Roughly two-thirds of actively-managed mutual fund managers fail to outperform the major stock indexes, such as the S&P 500, over long periods of time, such as 10 or 15 years. If the pros can't do it, what makes an individual think they can be the indexes? You could possibly beat the pros, but you'll need to do your homework.
It may not be an either/or question but rather one of style vs. substance. Both mutual funds and ETFs achieve the goal of diversity through large numbers of holdings or a particular industrial sector or geographic region within one security. However, ETFs trade like stocks (they can be bought or sold intra-day, rather than by NAV at the end of the day of trading) but they also incur trading costs. Some investors use a combination of mutual funds and ETFs, especially with tactical asset allocation styles.
There are many reasons why you might consider using index funds, but a few of those reasons might include passive management, low costs, tax efficiency, low turnover rates, simplicity, and the list goes on.
In simple terms, the value investor is looking for stocks selling at a "discount;" they want to find a bargain. An effective means of gaining exposure to value stocks is to buy a mutual fund with a value objective. Rather than spending the time to search for value stocks and analyze company financial statements, a mutual fund investor can buy index funds; Exchange Traded Funds (ETFs) or actively-managed funds that hold value stocks.
As the name implies, 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.
The growth and income objective is a combination of two parts -- one part growth and one part income. Growth stock mutual funds, for example, hold stocks of companies that are expected to grow at a rate faster in relation to the overall stock market. Income funds seek to provide the investor a source of income through dividends. Income stock funds are similar and often interchangeable in meaning with Value Funds, which primarily invest in stocks that an investor believes are selling at a price that is low in relation to earnings or other fundamental value measures.
The value vs. growth debate is as old as investing itself. Which is best, value or growth? When is the best time to invest in value stock mutual funds? When is the best time to invest in growth stock mutual funds? Is there a smart way to balance both value and growth in one mutual fund? What happens to the debate when we enter index funds into the comparison?
Buy and hold investors believe "time in the market" is a more prudent investment style than "timing the market." The strategy is applied by buying investment securities and holding them for long periods of time because the investor believes that long-term returns can be reasonable despite the volatility characteristic of short-term periods. This strategy is in opposition to absolute market timing, which typically has an investor buying and selling over shorter periods with the intention of buying at low prices and selling at high prices.
The buy-and-hold investor will argue that holding for longer periods requires less frequent trading than other strategies. Therefore trading costs are minimized, which will increase the overall net return of the investment portfolio.
Fundamental analysis is a form of an active investing strategy that involves analyzing financial statements for the purpose of selecting quality stocks. Data from the financial statements is used to compare with past and present data of the particular business or with other businesses within the industry. By analyzing the data, the investor may arrive at a reasonable valuation (price) of the particular company's stock and determine if the stock is a good purchase or not.
Investors using technical analysis (technical traders) often use charts to recognize recent price patterns and current market trends for the purpose of predicting future patterns and trends. In different words, there are particular patterns and trends that can provide the technical trader certain cues or signals, called indicators, about future market movements. For example, some patterns are given descriptive names, such as "head and shoulders" or "cup and handle." When these patters begin to take shape and are recognized, the technical trader may make investment decisions based upon the expected result of the pattern or trend.
Tactical asset allocation is a combination of many of the previous styles mentioned here. It is an investment style where the three primary asset classes (stocks, bonds, and cash) are actively balanced and adjusted by the investor with the intention of maximizing portfolio returns and minimizing risk compared to a benchmark, such as an index. This investing style differs from those of technical analysis and fundamental analysis in that it focuses primarily on asset allocation and secondarily on investment selection.
This big picture view is for a good reason, at least from the perspective of the investor choosing tactical asset allocation, and something called Modern Portfolio Theory, which essentially states that asset allocation has a greater impact on portfolio returns and market risk than individual investment selection.
Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.