Are you confused about how to determine the right investment strategy or if you have adopted the right investment style? It can be tricky to know if you are on the right track with all the conflicting information available. Your investment strategy should be tailored to your financial goals, needs, and preferences. So here are a few things to consider to check you are on the right track
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Factors that influence your investment strategy
Investor Life Cycle
John Bogle described 5 types of investors in his book Bogle on Mutual Funds. The investor types include accumulators (age 25-50), the transition investor (age 51-65), the distribution investor (retirement age), the lump-sum investor (recipient of an insurance policy or inheritance), and the institutional investor. All the different types of investors have different needs.
For example, the type of investment strategy adopted by an accumulator will be different from that of the distribution investor. The main goal of the distribution investor should be income generation. This is because they will need to draw from their investments to live on. The following Vanguard Target Retirement Funds below perfectly Illustrates this. The closer the year of retirement, the higher the funds’ allocation to bonds. A higher bond ratio reduces the risk of the portfolio and also provides income.
Risk appetite
Risk is unavoidable when investing. The challenge is, to obtain higher returns, you need to incur more risk. Nevertheless, It is important to determine how much risk you are comfortable with. Your risk appetite is often a factor of your personality, your stage in the investor life cycle, and financial stability. Personality is all about your natural dispensation to risk. You will probably recognize your tolerance for risk by your reluctance to do certain things. Are you a very cautious person who is uncomfortable with losing money? You are likely more risk-aversed than a risk-taker.
Oftentimes, the ability to take on risk depends on the level of financial stability. If you have no (or underfunded) emergency funds or debts to pay off, it is sensible to take a risk aversed stance.
Lastly, another factor that could determine your risk appetite is your stage in the lifecycle. A financially stable accumulator has a longer time horizon and can take more risk, while a distribution investor at retirement would need to take a more cautious stance.
Financial stability
Like I wrote in my previous post: 7 things you need to do before you start investing, financial stability is the foundation to wealth creation. It is always best to deal with any outstanding debts and save for an emergency fund with the help of a budget before investing. A question that is often asked is whether you can pay off debts and invest at the same time. Technically you can, but it depends on the type of debt, how much, and the interest rate cost. However, the general rule is to tackle all non-mortgage debts first.
Debt freedom and an emergency fund enable you to invest without the urgent need for money. This allows for the longer time needed to ride through the waves of the short-term volatility that occurs in the market. That said, a strategy that can be adopted while paying off debt/ building an emergency fund is investing small amounts monthly. This provides a form of dollar-cost averaging and allows you to take advantage of time in the market.
Level of investment knowledge
If you are new to investing, it’s best to keep things very simple. A passive strategy in the first instance will help build your confidence. Both active and passive mutual funds will allow for this simplicity. There is a wide range of funds available and some are tailored to your risk preference.
However, if you are not sure how to pick funds, start with an index fund. An index fund is a fund that mirrors an index. For instance, the FTSE 100 (Financial Times Stock Exchange 100) is a list of the top 100 companies listed on the London Stock Exchange by market capitalisation. A typical FTSE 100 index fund will hold all the 100 stocks in the FTSE 100 index. This is a very easy way to achieve diversification which lowers risk. They are also usually very low cost.
Disposable time
I had to add this point because it is based on my personal experience. I invested in a stock that really tanked years ago. That is mainly because even though I didn’t intend to buy and hold it, life got so busy. I missed important announcements and the opportunity to react to some crucial news. An active strategy requires being active. So regardless of your investor profile, knowledge and horizon, think about how much time you can devote to monitoring your investments. This is one reason I don’t trade/speculate with a large proportion of my investment funds.
Also, I want to be able to switch off without having to follow the news or my investments actively. This is just due to the phase of life I am in. When following an active strategy, you can’t just zone out and take a break from following up on your investments. The fundamentals of a company might change and it will be necessary to sell. So consider what is happening in your life and choose a strategy that best fits with what you need to achieve and the structures you have in place to monitor everything.
Investment strategies
Having considered the above, what investment strategy should you adopt? Here are the 2 main strategies to consider:
Passive
A passive investment strategy is simply a buy and hold strategy. The most common method of following a passive strategy is by buying an index fund. The main feature of a passive investment strategy is that you are not doing much after you buy it.
Active
An active investment strategy is the opposite of a passive strategy as you will frequently buy and sell investments to maximise profit. This requires the ability to select winning stocks or recognise high-performing fund managers. When investing in single stocks, the ability to perform investment analysis, build a diversified portfolio and rebalance your stock portfolio is very important.
There are other investment strategies such as dividend investing, value investing, growth investing, dollar average investing, momentum investing, defensive strategies and so on which I am unable to cover in this post. However, they can all be used as an approach to investing.
What is the best strategy for you?
The best strategy is the one that suits your profile, goals, and personal circumstances. Remember to choose an investment strategy on the backdrop of your goals. You can adopt a strategy and review and switch when required. You can also mix and match which is what I do currently. I have an index fund as well as an active balanced fund (mix of shares and bonds). I also invest a small proportion of my portfolio in single stocks. Regardless of the strategy chosen, align this with your goals and seek to minimize costs.
Have a valuable week!