When you started to look into investing you might have been asking yourself which investment strategy to follow. If you search for the best investment strategy there will be different, sometimes even contradictory advice given. In this article, we will look at the most common investment strategies, discuss the pros and cons, and at least give our view, which will be based on different financial and personal situations.
What investment strategy is the best?
The best investment strategy is one, that is tailored to your personal situation and financial knowledge. You will have different needs and risk tolerance depending on your age and financial situation. Additionally, an investment strategy might also have to be tailored based on geopolitical and economic conditions.
In order to understand the best investing strategy for your situation, let’s look first at some general investment strategies, and then look further into what might be suitable for yourself.
General Investment Strategies
Let’s take a look at some of the more popular investment strategies.
Value investors are scouting the market for stocks, which are trading at a discount. The discount is determined based on the company’s intrinsic or book value. Value investors analyze the companies, earnings, profits, cashflows, branding, products, competitive advantage, moat, and so on. They dig deep into the companies to understand their potential.
They take advantage of market inefficiencies such as geopolitical events, or bad news, and will only buy a stock if they think, that is it significantly undervalued. They look at stocks, like a product that is on sale. Regardless if you pay the full price or the discounted price, you will get the same product of the same quality.
Metrics that they use are price to book value (P/B), price to earnings ratio (P/E), free cash flow, and others. They will usually analyze the business and determine a price, to which they want to purchase the stock, and document their analysis in Excel or other tools. They will then revisit the stock on a quarterly to annual basis, or if geopolitical events occur to see if the price of the companies has fallen to the level where they consider it as a buy.
Value investors usually calculate a margin of safety into the desired stock price, based on their risk tolerance, and will only purchase the stock, if this price is met. The margin of safety provides additional security to protect against unknown unknowns.
Value investing is a patience game. Value investors will only purchase when the stock meets their desired price, and if they understand the company well. So it can easily take 1-2 years until they feel confident about the stock, and the stock meets their desired price so that they hit the trigger.
Some of the most well known value investors are Warren Buffet, Benjamin Graham, and Charlie Munger.
Growth investors look for companies, that have an advantage, such as an advantage due to patents, advantage due to new technologies, and are therefore likely to grow quicker than competitors in their industry. They are less concerned about purchasing the stock at a higher price if they see the potential for growing revenue and profit.
Growth investors may be inclined to buy more risky small-cap stocks, as these are usually young and innovative companies, which want to grow fast. As small-cap companies are usually less well-capitalized, the risk is higher, that such a company could go bankrupt.
Growth investors look at historical earnings, expected forward earnings, profit margins, return on equity, stock performance and other metrics.
Thomas Rowe Price Jr was the founder of growth investing. One of the most well-known growth investors out there is most likely Peter Lynch, who has successfully applied a combination of value investing and growth investing.
Dividend / Income Investing
Income investing has the goal to generate a regular income through a stock’s dividends, bonds yield, or interest payments. Real Estate can also be applied to this strategy through buy to let properties or REITs. Income investors look at high yielding assets, for example, stocks that pay high dividends, high yielding bonds, or real estate, with a good rental return.
Income investors are interested to generate a steady cash flow through dividends or interest payments, rather than the appreciation of the asset itself. They are usually interested to build up a steady stream of income, unrelated to the price of the asset.
Small Cap Investing
Companies with the highest potential for massive growth can be found in small-cap stocks. Small-cap companies are usually young dynamic companies with big ideas that want to grow fast. Usually, these companies are very innovative and apply new technologies to get ahead of their competitors.
This is where the real gems can be found. However, these companies might not yet be profitable and might also be less well-capitalized which means that the risk that they go bankrupt is much higher than with established companies. This category of stocks is subject to much higher market fluctuation and is therefore rather suited for experienced investors.
However, if you know a sector or industry very well, you might just have the right edge of expertise. For example, you might know the sector you are working in well. That’s where you might have the advantage to find some gems. But you will need to be able to look at and understand financial statements, to see how the company is financially doing, to get in and pull out at the right time.
As these investments are rather high risk and high gain, it is advisable to only invest between 5 and 20% towards such more risky bets.
Socially Responsible Investing
In today’s day and age, investors become more and more socially responsible and build these ethics into their investment approach. They want to ensure, that the companies do responsible things, and with it, turn the world into a better place.
These investors will never invest in coal fired power stations, companies that produce cigarettes, and so on. They will only invest in companies they believe will bring high benefits to humans and nature.
They will either pick their own stocks, or choose a fund or ETF which caters towards ethically and social responsible investments.
Real Estate Investing
Investors can also invest in real estate. For example in rental properties, or properties in upcoming areas, which will appreciate in price over time. Another option is to invest in REITs (Real Estate Investment Trusts), which offer an investment into real estate, similar to stocks.
All of these strategies work best under specific market conditions, and investors might have other objectives than just monetary ones. In recent years, for example, growth stocks have outperformed value stocks, as due to the global pandemic several countries floated the stock and bond markets with cash, which means that many stocks were rather overvalued than undervalued.
It also comes down to the personal preference and edge of the investor. Some investors will simply stick with their strategy, while other investors will change to a different strategy if market conditions change.
If you trade your own money you can take more risk and endure longer downturns, while if you invest other people’s money you might rather trade in a way, where you ensure the growth of customers’ accounts, by adjusting the strategy to adhere to the risk tolerance of your clients.
Geopolitical and Economic Conditions
It is important to take geopolitical and economic conditions into account. For example, there are many good and cheap companies to invest in, in Argentina. But the country is going through a long-term recession, and hence the price of the stock of these companies remains low. This will not change before the country has found a way to get out of the recession, and the chance of this happening short-term doesn’t look very good.
As a “Value Investor” you could take the standpoint, that because the companies are cheap, it is a good time to buy, and hope that Argentina at some point will come out of the recession, but this can potentially take another decade. Or the situation could get even worse.
The conclusion here is that analyzing the company alone is not sufficient. You will need to analyze also the larger macro environment around the company. The company might do very well, but if the country the company operates in doesn’t do well, this will have an impact on the company itself.
Use common sense
Invest only in what you understand
Take financial advisors with a pinch of salt
It is important that you spend time to build up at least basic financial knowledge, so that you know what a financial advisor is proposing to you. There are many good and honest financial advisors out there, but you should never forget, that in the end, they help you because they get paid by you directly, or they will get a commission from the company of the product, they propose to you. This can cause a conflict of interest, and therefore it is important, that you know in what you invest, and check some alternatives to compare the price.
If anyone promises you returns over 10-15% per annum be skeptical
The average return of the stock market over the last 10 years was around 9.2%. Based on this an investor usually can expect returns between 5 and 15%. Experts can reach higher returns by a selection of specific companies or sectors. But even the best investors are usually not able to achieve consistent returns over 20% over several years. So if someone is offering you 30% or even higher returns, your internal alarm bells should go off, and you should be very alert and skeptical, as this is usually too good, to be true.
Investing is a very large area, in which you can learn a lifetime. Analyzing stocks of companies, in sectors you’re unfamiliar with, will take a large amount of time, but can also be incredibly interesting as you’ll get to know the companies really well.
If you have no experience in reading financial statements of companies, and following their shareholder meetings, investing in stocks directly might not be for you, because this is usually required to take buy and sell decisions. In such cases investing in mutual funds or ETFs might be more suited for you, as the risk is better diversified, and/or you have a professional money manager that manages these decisions for you.
Even professionals don’t always get it right, and I can tell you from experience that stock picking isn’t easy. Watching stocks fall into the abyss can be pretty stressful, because you’ve overlooked something, or the market just didn’t react to the fundamentals as you’ve hoped it would.
Therefore if you are a beginner, with insufficient financial knowledge and time, you will do yourself a big favor, starting out with a mutual fund or ETF, and get some more knowledge, before investing in stocks directly.
Age & time horizon
How you invest will also be dependent on your age and time horizon. If you are young and have time to build up your wealth, you can take a riskier approach, than when you’re 55 and want to retire at 65. Then it might make more sense to place safer bets to make sure your capital is preserved.
Available time and interest
If you invest in stocks directly, you’ll need to be able to read financial statements or learn how to do it. You will need to learn to compare companies within the same sector, learn what products they have, how they make their money, how their management operates, and what competitive advantages they have, to find the right stocks. This will take up a lot of your time.
When investing in mutual funds, you’ll let a professional do this job for you, and if you invest in ETFs then you’ll expect the general returns of the market.
If you invest in real estate, you need to deal with the tenants or find a property management company, which will do it for you. If you buy REITs, the management will be done for you, without you, having to invest time in it.
It will depend on the cash you can put towards an investment. If you have hundreds of thousands of dollars, then diversifying into real estate, stocks, mutual funds or ETFs might be the best choice, while if you have a few 100 dollars, it might make more sense, to put all towards ETFs.
Especially when you begin to invest, you might perceive risk in a different way, then seasoned investors. Seasoned investors are very open to risk and market volatility, once they’ve seen their assets grow over time, and they know what works well and what doesn’t. But if you are an inexperienced investor and you hear the word “risk”, you might say “no, I don’t want that risk”, which will lead to less risky investments, but also less lucrative ones.
So what is the best investment strategy to invest?
The “best” investment strategy will be perceived differently by different people. Therefore the answer isn’t that straightforward. The investment strategies proposed to you here are generally save. But you will have to do your own due diligence, and take your own risk when investing your money. Nobody will take that risk for you! The positive thing is that you will learn, what works and what doesn’t, and after a year or two, you will have a much better understanding of what works for you. If you give your money blindly to somebody else, they will learn from their mistakes with your money!
If you start out new, never invest all the money, keep cash reserves in case you lose your job, start small, and grow your account over time. It is time you’ll need to become a good investor and get a feeling of what works for you and what isn’t.
The best strategy to invest as unexperienced investor
If you are inexperienced, we recommend starting with ETFs and Mutual Funds. ETFs usually have a very low cost, and you can start by investing very small sums, while mutual funds are managed by money professionals.
Banks usually only invest your money into mutual funds, if you have a minimum investment sum, as otherwise, it’s not lucrative for them. If you can’t reach that minimum sum, then going for low-cost ETFs will usually be the best option.
Does that mean you will be fully hands-off? No, not necessarily. In order to build up your financial knowledge, you can start looking at the world, and sectors and see where there is potential growth. If you see, for example, that tech companies in China have been growing more in comparison to the US, then you can invest in an ETF or Mutual Fund, that caters to these stocks.
The best strategy to invest as investor with insufficient time
If you have insufficient time to manage your investments, then it is advisable to invest in mutual funds and ETFs, because in order to pick stocks, you need to have the time to analyze the companies in detail. You can still take an active role, by investing in mutual funds and ETFs in sectors or countries, you expect growth.
If you have more cash at hand, you could split between mutual funds, ETFs, and REITs. Or you could buy a real estate property, that will be managed by a real estate management company.
If you have some time at hand, and you want to invest in stocks, you could analyze companies in sectors you are experienced in and put 10% to 20% of your investment towards purchasing stocks to gain exposure. If you buy small caps, clearly analyze the risks, as if the company goes bankrupt, you could lose this money completely.
The best strategy to invest with a low risk tolerance
If you want to completely avoid market risk, you can invest in time deposits, or with a little more risk you can invest in government bonds or bonds of large high-rated companies. You can also invest in a mutual fund, which will give you exposure to 80% highly rated bonds, and 20% stocks for example. This is how you can tip your toes into the cold water. Or you invest 80% fully into bonds, and 20% fully into a stock index such as the S&P500 through an Index Fund or ETF, to get more exposure and build up the knowledge to understand risks vs rewards.
At some point, if you want to have higher returns, you will need to expose yourself to market risk. What you can make sure of, as a defensive investor that you have done your due diligence to understand the risks in detail, and chose a fund or ETF, with established key companies.
The best strategy to invest with 50+
At this age, you want to make sure you preserve your capital, so at least 50-60% or more should be in more defensive investments such as time deposits, high rated bonds, and/or real estate. The other 40-50% can still be in stocks, or if you want to be more defensive and you have sufficient capital, you might put 70-80% towards bonds and 20% towards stocks. When talking about stocks and bonds I also refer to stocks and bonds in mutual funds or ETFs.
Stock markets can take dives, and even though most dives only take up to 2 years, there have been phases where stocks went sideways for a longer period of time.
It will depend on the financial knowledge you’ve built up over time. I know many old people which are retired and got very savvy in finance and very experienced investing their money. Others are hands-off and have their money in mutual funds that pay out dividends, or in specially taxed optimized income investments.
The best strategy for experienced investors
Experienced investors will have already found their investment strategies, and therefore won’t need any further advise.
- It helps to build up your own investment knowledge and start to take investing your money into your own hands.
- If you engage an investment advisor, understand that there is a conflict of interest, be alert to what you sign up for, and get a second opinion.
- If you have no investment knowledge, then Mutual Funds or ETFs will most likely be the better choice than investing directly into stocks or bonds, especially because with mutual funds and ETFs you’ll be better diversified. If a company goes bankrupt, it won’t hit you that much.
- If you have insufficient time, investing in stocks and bonds directly, is also not the right choice, as analyzing companies, or managing real estate can be time-consuming.
- If you are very scared of investing, or if you are at retirement age, then invest more defensively, into higher graded bonds, time deposits, and less exposure to stocks.
It can be daunting to start investing, but once you get the hang of it and see the rewards it will be worth it. All the best luck with your choices and investments!