What are Investment Strategies?
Investment strategies are strategies that help investors chose where and how to invest as per their expected return, risk appetite, corpus amount, long-term, short-term holdings, retirement age, choice of industry, etc. Investors can strategies their investment plans as per the objectives and goals they want to achieve.
Top 7 Types of Investment Strategies
Let’s discuss different types of investment strategies, one by one.
#1 – Passive and Active Strategies
The passive strategy involves buying and holdingStrategy Involves Buying And HoldingThe term "buy and hold" refers to an investor's investment strategy in which they hold securities for a long period of time, ignoring the ups and downs in market price during a short period of time. stocks and not frequently deals in them to avoid higher transaction costs. They believe they cannot outperform the market due to its volatility; hence passive strategies tend to be less risky. On the other hand, active strategies involve frequent buying and selling. They believe they can outperform the market and can gain more returns than an average investor would.
#2 – Growth Investing (Short-Term and Long-Term Investments)
Investors chose the holding period based on the value they want to create in their portfolio. If investors believe that a company will grow in the coming years and the intrinsic value of a stock will go up, they will invest in such companies to build their corpus value. This is also known as growth investingGrowth InvestingGrowth Investing refers to capital allocation in potentially high earning companies such as small caps and startups, which grow much faster than the overall industry or mature companies. Because the returns on such investments are high, the risk that such investors face is also higher.. On the other hand, if investors believe that a company will deliver good value in a year or two, they will go for short term holding. The holding period also depends upon the preference of investors. For example, how soon they want money to say to buy a house, school education of kids, retirement plans, etc.
#3 – Value Investing
Value investing strategy involves investing in the company by looking at its intrinsic value because such companies are undervalued by the stock market. The idea behind investing in such companies is that when the market goes for correctionMarket Goes For CorrectionMarket Correction is usually referred to as a fall of 10% or more from its latest high. It happens due to various reasons such as declining macro-economic factors, intense pessimism across the economy, securities specific factors, over-inflation in the markets, and so on., it will correct the value for such undervalued companies, and the price will then shoot up, leaving investors with high returns when they sell. This strategy is used by the very famous Warren Buffet.
#4 – Income Investing
This type of strategy focuses on generating cash income from stocks rather than investing in stocks that only increase the value of your portfolio. There are two types of cash income which an investor can earn – (1) DividendDividendDividend is that portion of profit which is distributed to the shareholders of the company as the reward for their investment in the company and its distribution amount is decided by the board of the company and thereafter approved by the shareholders of the company. and (2) Fixed interest income from bonds. Investors who are looking for steady income from investments opt for such a strategy.
#5 – Dividend Growth Investing
In this type of investment strategy, the investor looks out for companies that consistently paid a dividend every year. Companies that have a track record of paying dividends consistently are stable and less volatile compared to other companies and aim to increase their dividend payout every year. The investors reinvest such dividends and benefit from compoundingCompoundingCompounding is a method of investing in which the income generated by an investment is reinvested, and the new principal amount is increased by the amount of income reinvested. Depending on the time period of deposit, interest is added to the principal amount. over the long term.
#6 – Contrarian Investing
This types of strategy allow investors to buy stocks of companies at the time of the down market. This strategy focusses on buying at low and selling at high. The downtime in the stock marketStock MarketStock Market works on the basic principle of matching supply and demand through an auction process where investors are willing to pay a certain amount for an asset, and they are willing to sell off something they have at a specific price. is usually at the time of recession, wartime, calamity, etc. However, investors shouldn’t just buy stocks of any company during downtime. They should look out for companies that have the capacity to build up value and have a branding that prevents access to their competition.
#7 – Indexing
This type of investment strategy allows investors to invest a small portion of stocks in a market index. These can be S&P 500, mutual fundsMutual FundsA mutual fund is an investment fund that investors professionally manage by pooling money from multiple investors to initiate investment in securities individually held to provide greater diversification, long term gains and lower level of risks., exchange-traded funds.
Here are a few investing tips for beginners, which should be kept in mind before investing.
- Set Goals: Set goals on how much money is required by you in the coming period. This will allow you to set your mind straight whether you need to invest in long-term or short-term investments and how much return is to be expected.
- Research and Trend Analysis: Get your research right in terms of understanding how the stock market works and how different types of instruments work (equity, bonds, options, derivatives, mutual funds, etc.). Also, research and follow the price and return trends of stocks you chose to invest.
- Portfolio Optimization: Select the best portfolio out of the set of portfolios which meet your objective. The portfolio which gives maximum return at the lowest possible risk is an ideal portfolio.
- Best Advisor/Consultancy: Find yourself a good consulting firm or brokerage firm. They will guide and give consultation regarding where and how to invest so that you meet your investment objectives.
- Risk Tolerance: Know how much risk you are willing to tolerate to get the desired return. This also depends on your short term and long term goals. If you are looking for a higher return in a short period of time, the risk would be higher and vice versa.
- Diversify Risk: Create a portfolio that is a mix of debt, equity, and derivativesDerivativesDerivatives in finance are financial instruments that derive their value from the value of the underlying asset. The underlying asset can be bonds, stocks, currency, commodities, etc. The four types of derivatives are - Option contracts, Future derivatives contracts, Swaps, Forward derivative contracts. so that the risk is diversified. Also, ensure that the two securities are not perfectly correlated to each other.
Advantages of Investment Strategies
Some of the advantages of investment strategies are as follows:
- Investment strategies allow for diversification of risk in the portfolio by investing in different types of investmentsDifferent Types Of InvestmentsStocks, bonds, and cash equivalents are the three main forms of investments. Investment, in general, refers to the purchase of anything for future use with the goal of generating a regular cash flow or increasing the value of something over time so that it can be sold for a higher price than it was purchased for, i.e. capital gains. and industry based on timing and expected returns.
- A portfolio can be made of a single strategy or a combination of strategies to accommodate the preferences and needs of the investors.
- Investing strategically allows investors to gain maximum out of their investments.
- Investment strategies help reduce transaction costs and pay less tax.
Limitations of Investment Strategies
Some of the limitations of investment strategies are as follows:
- Average investors find it difficult to outperform the market. To earn an average return from investments, it may take them years, whereas professional investors would earn the same return in weeks or months.
- Even though a lot of research, analysis, and historical data are considered before investing, most of the decisions are taken on a predictive basis. Sometimes, the results and returns may not be as it was anticipated, and it may delay the investors from achieving their goals.
It is very important to have an investment strategy. It will help you rule out poor portfolios and will increase the chances of success. Ask yourself a few basic questions like how much I want to invest? How much return do I need? How much is my risk toleranceRisk ToleranceRisk tolerance is the investors' potential and willingness to bear the uncertainties associated with their investment portfolios. It is influenced by multiple individual constraints like the investor's age, income, investment objective, responsibilities and financial condition.? What will be my investment horizon? Why did I need to invest? Etc. The clearer you are with your objectives, the better decision you will make regarding your investment. Always lookout for good opportunities and never invest at one go. Building a portfolio is like building a house brick by brick, money by money.
This has been a guide to what are investment strategies and its definition. Here we discuss different types of investment strategies along with advantages and disadvantages. You can learn more from the following investment and asset management articles –