There are a lot of investment styles you can use when you participate in the stock market. We review how they work.
There are many schools of thought when it comes to investing, but the main rules still stand out:
(1) Invest early. (2) Invest regularly. (3) Stay invested.
After following these three rules for sometime, you should find yourself happily sitting on a nice pile of dough. But having waded through so many finance and investing books through the years, I continue to be fascinated by the various investment styles that have been used by so many successful investors and fund managers to generate that pile of dough. Care to know a little about some of them?
When you plunk down your money into a stock or fund, you release that money into a market heavily studied by investment strategists and money gurus. Don’t worry since many of them are already working for you, when you’re invested in mutual funds. But in case you’ve been doing your own investing without a professional involved, it may be good to know a few of the investing styles used out there by market players who constantly want to gain an edge. Here are some descriptions of contrasting strategies that exist in the market place and my own confessions about which styles I subscribe to.
Investment Styles For Any Portfolio
#1 Technical Versus Fundamental Analysis
I’ve described technical analysis versus fundamental analysis in the past and even included pretty pictures in the mix. Technical analysis involves using timing indicators and triggers. I’ve encountered a few folks who have decided that trading was the way to go to make some bucks. They play the market in their spare time by trading on volatility. Traders love it when market prices shift dramatically because that’s when they make money on their positions. A quiet and boring market is a money loser for them. On the other hand, fundamental analysts are most of us who are long-term investors. We keep the money in the market and minimize trades because we’re banking on the solid earnings of corporations and a nicely running economy to keep our money growing. On this note, I’m definitely on the camp of long term investing.
#2 Growth Versus Value
Value investors are those who buy lower valued stocks based on fundamentals and corporate balance sheets. They are looking to buy stocks of businesses that are currently unpopular, underestimated in terms of earnings or undiscovered by the market herd. They hope to buy stock at low price points in order to reap the largest gains when the tide turns in favor of these stocks. Meanwhile, growth investors favor stocks that have expected high future growth rates. It doesn’t matter whether a growth stock is expensive in terms of its price/earnings multiple, just as long as its future is bright and earnings remain strong. Small stocks are often in this realm as they go through growth spurts in a huge way. I personally put my money in blended funds — those that have equal representation in growth and value equities since I’d like to have some level of participation in whatever style is fashionable at any one time.
#3 Contrarian Versus Momentum
Contrarian investors like to go against the herd. Either buying stocks that everyone hates or going against what the investing crowd does. When the market dies, they buy. Most of the time, they just sit quietly in the wings, waiting for the opportunity to buy on dips. An example of contrarian investing is the Dogs of The Dow approach. Whereas momentum investors are just the opposite: they are what I call the “rah-rah” investors. They love to pump up the market. When things are going well, they buy on strength hoping to catch the momentum of the bull. The “momo” investors’ motto: Buy High, Sell Even Higher. I don’t know about you but I find it a challenge to buy when the market has been surging for some time. I’m really a pseudo-contrarian at heart.
#4 Active Versus Passive (Indexing)
Do you like to fuss over your portfolio? If you are, or if you’ve invested in what they call “actively managed mutual funds”, then you’re pursuing the active investment style. You’re an active investor if you tinker with your portfolio a lot to try to beat market returns, quite often racking up a good amount of transactional activity. If you’ve sent your money off to funds that have fund managers doing investment research and trades in your behalf, then by association, you’re an active investor. If in the meantime your investments are simply tracking an index determined by a third party, then you’re investing “passively”.
So which approach is superior? Reports such as those provided by Lipper Analytical Services have trumpeted the fact that most actively managed equity mutual funds underperform the S & P 500 Index. I’d love to see some hard statistics on this, for sure, but this is a point that many “indexers” and passive investors like to boast about when justifying their love for index funds or index ETFs.
Indexing is a great way to go if you are ready to accept slight under-performance by funds that are tracking their actual indexes. Funds that follow indexes have slightly lower returns due to minimal management fees and transaction costs incurred by these funds. After all these years of investing, I’ve accepted indexing as my core investment style of choice, for the simplicity and convenience it offers me.
#5 Asset Allocation
It’s a no-brainer: practicing asset allocation and diversification by utilizing any or all of the aforementioned investment styles to achieve your financial goals are very wise moves. I’ve tried quite a number of strategies in the past that involved trading, shorting, leverage, concentrated positions, and so forth and nothing made me more money and gave me less headaches than long term investing using the passive or indexing approach. For average investors, I think this is the most reasonable and sensible way to invest. Unfortunately, many decide to go this route only after getting burned by the market at some point in their investing careers.
There are other investment styles such as those that involve choosing which market caps you’d like representation in (e.g. small to large company investing) or top down vs bottom up strategies. Sometimes it’s a pattern of behavior, at other times, it’s about following what’s in fashion. For further diversification, I’ve tried to find representation of these styles in my own portfolio as they can co-exist in various capacities. At first, these various styles can make your head spin but if you’re going for simplicity, nothing beats passive investing. It’s a good place to start…and end!
Image Credit: Thank you to AmazingIllusions.com for their fun images. This post first appeared on September 6, 2007
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