Investment strategies: Guide for beginners
Investment strategies: Guide for beginners
Investment strategies: Guide for beginners
Many people start by building toward retirement. You can use a retirement calculator to see how much you can or may need to save for your golden years, and then begin slowly learning investing strategies to get to that point in the future. You might also consider how debt management and intelligent resource planning play a role in growing your assets for the future. Of course, everyone has to start somewhere. Learn more about investment strategies and types below.
What is an investment strategy?
An investment strategy is a plan you create and principles you rely on to help you make investment decisions. The exact investment strategy you use depends on factors such as:
- Your financial goals. How much wealth do you want to build? What's the timeline for building that wealth? Someone who's starting in their 20s might begin by maximizing their 401(k) contributions, for example. But if you're only seven years from retirement, you may need to do more to save enough for the near future.
- Your risk tolerance. Risk tolerance refers to how well you can deal with the risks of investing. If you have a low risk tolerance — for example, you can't afford to lose much in your investments or you desire to play it safe all the time — your investment strategy will be more conservative than if you have a high risk tolerance.
- Your current financial situation. How much you can afford to save or invest at this time impacts your overall investment strategy.
An investment strategy is not something you pick and stick with your entire life. You should reconsider your investment strategy periodically and update it to meet your new goals, risk tolerance and financial situation.
4 types of investment strategies
Investing strategies can be simple or complex, typically involving unique factors for each individual. The summaries below reflect high-level strategies that you may consider.
Value investors look to find stocks that are trading at a discount to their intrinsic value. They believe the market overreacts to news, good or bad, resulting in stock price movements that do not correspond to a company's long-term fundamentals.
Investors "bet" on stocks rising in value when certain news hits. They buy the stock before the potential news and may sell it afterward when the price increases. An example of this type of strategy is buying a pharmaceutical stock knowing that the company has a medication up for approval by the FDA. Betting that the FDA will approve the medication and the stock will go up is one way to potentially get a lot of value from a stock purchase and subsequent sale.
Pros and cons of value investing
Value investing can be done by anyone, and you don't need a lot of money to invest this way. You can start small. However, this strategy does require paying attention to the markets and news and analyzing data to help make investment decisions.
Growth investing is, in some ways, the opposite of value investing. With this strategy, you would choose stocks of companies in rapidly growing industries or sectors where new products or technologies are being developed.
Typically, growth investors look for emerging companies or industries with promise, but they may also invest in tried-and-true securities that have a history of gains. You realize gains through capital appreciation when you sell the stock. Typically, growth stocks do not pay dividends.
Pros and cons of growth investing
Growth investing has helped a lot of people build wealth over time. Consider, for example, someone who invested in Apple or Amazon stock in the early years — many people put kids through college or funded their own retirement on those investments. That's the biggest benefit of this strategy. The downside is that there is always risk, and you may need to be patient to see any returns.
Dollar-cost averaging is a way that many investors develop consistent investing habits. You take the same dollar amount and buy shares each period regardless of the share price. Because share prices go up and down, the thought is that your share price will average out over time.
For example, perhaps you have $200 to invest every month in a certain stock. You buy $200 of that stock every month whether share prices are $3 or $6. Over time, you hope that the average price you pay for the shares is on the lower end of the range.
Pros and cons of dollar-cost averaging
Dollar-cost averaging is a great way to build consistent investment habits, especially if you start with an amount you can afford and pick a good security or stock. However, because the market has historically tended to rise over time, you may have to be careful not to stretch out your purchases too much.
Dollar-cost averaging can be a good plan for investors looking to stay disciplined or who worry about taking on immediate investment risk. However, lump-sum investing tends to outperform dollar-cost averaging over time.1 Lump-sum investing does come with additional risk and a stomach for volatility.
Income investing is a strategy that looks to generate income rather than build a foundation of wealth that can be drawn upon in the future. When someone engages in income investing as a strategy, they look for investments that are likely to pay out in the short term as well as investments that will continue to pay out over a longer period.
Some examples of assets that work for income investing include real estate, such as mortgage securities and rental property, as well as bonds and stocks that pay dividends. Annuities, certificates of deposit (CDs) and money market accounts are other common income investing tools.
Pros and cons of income investing
Obviously, the fact that you might be able to generate ongoing income with your investments is a big benefit of this strategy. Another benefit is that you can tailor this approach to meet your risk profile. For example, CDs come with very little risk. While the associated income isn't huge, it can be relied on. Downsides to this strategy can include having to keep up with inflation, potential losses that interrupt income streams and the impact of public policy and market forces on your income.
The 3 main types of investments
Within different approaches to investing, you’ll have various types of investments, such as stocks or bonds. While you can also invest in property, including real estate, collectibles such as fine art, and cash equivalents like CDs, we’ll cover the three main types of securities investing.
Stocks are created by companies that want to raise funds. They use the funds to get started or fund growth. When you invest in stock, you're really investing in the future outcome of the company, so it's important to do your research and choose wisely.
Investing solely in stocks can be risky because the overall performance of the market has a huge impact on the performance of individual stocks or groups of stocks. Investing in a single stock is extremely risky because you tie all your success (or lack of it) to the performance of a single company. Instead, strategies for investing in stocks usually take into account the need to diversify.
Stocks let you purchase an interest in a company. Bonds let you lend money that you expect to be repaid with interest. You can buy bonds issued by governments or private companies. These are purchased for a set period of time before they're paid back with interest when they mature, so this can be a good way to have a stable income coming at a certain point in time.
However, bonds aren't completely without risk. One of the biggest risks is related to interest rates; when interest rates rise, bond prices tend to fall. Also, if the entity issuing the bond experiences a financial issue or goes bankrupt, you may never see a return. Because of this, government bonds are typically considered safer though they pay at lower rates than some private bonds.
Pooled investment vehicles, such as mutual funds and exchange-traded funds (ETFs), enable you to invest in a combination of securities through a single purchase.
Funds can be either actively managed or passively managed. Actively managed funds have investment decisions made by a fund manager following a specific investment strategy. Passively managed funds replicate the investments in a securities index such as the S&P 500.
Index funds are not usually actively managed, so they come with lower fees. The portfolio manager for an actively managed fund tries to outperform a benchmark index over the long-term by making investment decisions based on market analysis and fundamentals. This type of management comes with higher fees.
Given the portfolio diversification within mutual funds and index funds, many people use this style of investment in a long-term investment approach.
Other types of investing
It's worth noting that you can potentially grow your money in other ways.
Some alternatives include:
- Savings accounts. While high-yield savings accounts provide a relatively low interest income, they can be safe ways to set aside money you might need in the short term while earning a little bit too. For instance, high-yield savings accounts may be a good option for your emergency fund.
- Real estate. Even the home you live in might be an investment if you're building equity. You can borrow against that equity or sell your home for a profit in the future.
- Precious metals. Gold and silver are popular investments, and you can invest directly in them, hold them in a precious metal IRA or invest in securities that track the performance of precious metals. This can be a good way to diversify your portfolio because gold may outperform when other securities are falling.
- Collectibles. Some people also like to invest in fine art, jewelry coins or other collectibles. This type of investment comes with many risks, and you can't always be sure you can convert these assets to cash as needed.
Ultimately, there is no magic investment type that works all the time or for every individual. This is why you hear so much about the importance of diversification when it comes to building an investment portfolio.
Because the market is always moving up and down and so many factors can come into play, using multiple investment types may help you create a more stable portfolio of investments that has the potential to grow over time.
1 Experian, “How to Choose Between Dollar Cost Averaging and Lump-Sum Investing,” March 2022.
The S&P 500 Index is a registered trademark of Standard & Poor’s Financial Services LLC. It is an unmanaged index considered indicative of the domestic large-cap equity market and is used as a proxy for the stock market in general.
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