Table of Contents
Select a plan that matches your profit goals and abilities.
An investment strategy is a set of rules that help you decide where to invest your money. You can choose from various plans based on your comfort with risk, your investing approach, your future financial aims, and the amount of money you have available to invest.
Investing strategies can be adjusted if they don’t match your comfort level with risk or schedule. However, changing your strategy can have drawbacks. You might face taxes each time you buy or sell investments, especially in non-tax-advantaged accounts over a short period. Additionally, you might realize your portfolio is riskier than you’d like after its value has dropped.
This guide explores four popular investing strategies suitable for most investors. By learning about each strategy, you can choose the best one for your long-term goals without spending money on changing your plan later.
KEY TAKEAWAYS
- Before deciding on your strategy, jot down information about your finances and what you want to achieve.
- Value investing means sticking with your investments for a long time and putting in effort to research and choose stocks carefully.
- Investors using growth strategies should watch company executives and economic news.
- Momentum investors purchase stocks that are rising in price and might also choose to short-sell those stocks.
- Dollar-cost averaging means regularly investing in the market over time.
- Dollar-cost averaging means regularly investing money in the market over some time.
Getting Started
Before you start researching your investment plan, gathering some basic details about your financial situation is crucial. Consider these important questions:
- What is your current financial status?
- What are your living costs, including monthly expenses and debts?
- How much money can you invest regularly at the beginning?
While you don’t need much money to begin investing, ensuring you’re financially ready before you start is important. If you have debts or other financial responsibilities, consider how investing might affect your immediate cash flow before investing.
Investopedia Essentials
Try The Investopedia Stock Simulator
Are you new to investing? Practice trading in real-time with our virtual simulator. Our platform teaches you effective strategies for growing and managing wealth.
Important: Before investing, ensure you have the funds available. Focus on your current responsibilities before saving for the future.
Next, outline your financial goals. Identify what you’re saving for – whether it’s retirement, buying a home or car, or funding education. This will help you choose the right investment strategy, considering liquidity, opportunities, and risks.
Then, assess your risk tolerance. This is influenced by factors like your age, income, and time until retirement. Younger investors can take more risks as they have time to recover from losses.
Additionally, consider your emotional comfort with risk. How would you feel if your investments suddenly dropped in value? If the thought makes you uneasy, your portfolio might have too much risk for your comfort level.
Risk-Reward Relationship
Risk isn’t always negative in investing. Higher-risk investments can lead to higher returns, while lower-risk ones are safer but offer lower potential gains.
Lastly, grasp the fundamentals of investing. Learn to interpret stock charts and start by selecting a few companies you like. Analyze their financial statements and stay updated on news about the industries you’re considering investing in. Understanding your investments is important so you can make informed decisions.
Strategy 1: Value Investing
Value investors are like savvy shoppers. They search for stocks they think are priced lower than they should be, stocks whose prices don’t accurately represent their true value. Value investing is based on the belief that the market isn’t always rational. This means there are chances to buy stocks at a lower price than they’re worth and profit from them.
Value investors don’t have to dig through financial data to find good deals. There are thousands of value mutual funds where investors can buy undervalued stocks. For instance, the Russell 1000 Value Index is a popular benchmark for value investors, and many mutual funds follow this index.
For those who don’t have time for extensive research, the price-earnings ratio (P/E) is a key tool. It’s a simple number calculated by dividing a stock’s price by its earnings per share (EPS). A lower P/E ratio means you’re paying less for each dollar of current earnings. Value investors look for companies with a low P/E ratio.
Who Should Use Value Investing?
Value investing is ideal for investors who plan to keep their investments long. Investing in value companies may take years or even longer for their businesses to grow significantly. Value investing focuses on long-term growth and often takes a patient approach.
Legendary investor Warren Buffett is often seen as the ultimate value investor. For example, when Buffett invested heavily in the airline industry, he mentioned that airlines had a tough start but hoped they had gotten through the worst of it. This reflects the value investing approach, where decisions are based on long-term trends and future performance.
Over time, value investing has usually given better returns. But there have been times when it hasn’t done as well as growth investing for extended periods. For example, a study by Dodge & Cox found that value strategies trailed growth strategies for about ten years out of the last 90 years. These times included the Great Depression (1929-1939/40), the Technology Stock Bubble (1989-1999), and 2004-2014/15. Since 2007, value investing has consistently done worse than growth, dropping over 50% by 2020. It’s uncertain if value stocks will improve their performance soon.
Pros and Cons – Value Investing
Pros
- As the market recognizes a company’s true value, there’s a chance for big gains in the long run.
- Value companies typically offer better risk-to-reward ratios.
- Value investing relies on studying a company’s basics and is often backed by financial measurements.
- Value companies pay dividends more frequently because they don’t need as much cash to grow.
Cons
- Finding value companies can be challenging, especially since earnings can sometimes appear higher due to accounting methods.
- Successful value investments require patience, and investors must be willing to wait.
- Even if you hold onto a stock for a long time, there’s no guarantee it will succeed – the company might even end up in a worse situation than before.
- Putting all your investments into poorly performing sectors reduces your portfolio’s diversity.
Strategy 2: Growth Investing
Instead of seeking inexpensive deals, growth investors aim for investments with high potential for future earnings. They’re often on the lookout for the next big opportunity. However, growth investing isn’t about taking reckless risks. It involves assessing a stock’s current condition and its growth potential.
One downside of growth investing is the lack of dividends. Growing companies usually need capital to support their expansion, leaving little or no cash for dividend payouts. Additionally, faster earnings growth often leads to higher valuations, which can be riskier for most investors.
While there isn’t a definitive list of metrics for guiding a growth strategy, some factors to consider include how growth stocks typically perform during declining interest rates. Lower rates can make it cheaper for newer companies to borrow money for innovation and growth. However, it’s important to note that growth stocks are often the first to suffer in an economic downturn.
Growth investors also need to assess the management skills of a company’s executive team. Achieving growth is a tough task, so strong leadership is crucial. Investors should also evaluate the competition because even if a company experiences rapid growth, easily replicable products can dim its long-term prospects.
Who Should Use Growth Investing?
Growth investing carries more risk and tends to perform well only during specific economic situations. It’s best for investors seeking shorter-term gains and willing to take on higher risks than value investing. Growth investing suits those not focused on immediate cash flow or dividends.
According to a study from New York University’s Stern School of Business, growth investing may not always outperform value investing, especially over long periods. However, there are times when growth investing shines. The challenge lies in predicting when these favorable periods will occur. While trying to time the market is not recommended, growth investing is most appropriate for optimistic investors about future market conditions.
Since growth companies are often smaller and newer with less established market presence, they’re more prone to bankruptcy than value companies. Therefore, growth investing may be better suited for investors with higher disposable income, as there’s a greater risk of capital loss than other investment strategies.
Pros and Cons – Growth Investing
Pros
- Growth stocks and funds focus on increasing in value over the short term. If you make money, it typically happens faster compared to value stocks.
- When growth companies start to expand, they often see the biggest and fastest increases in their stock prices.
- Growth investing doesn’t rely as much on technical analysis and can be simpler to start investing in.
- Growth companies can often gain momentum; once they start growing, they’re more likely to keep growing, increasing stock value.
Cons
- Growth stocks are usually more unpredictable. When things are going well, they’re great, but if a company stops growing, its stock price can decline.
- Depending on the overall economic situation, growth stocks might be held onto for the long term. For instance, rising interest rates can be challenging for growth companies.
- Growth companies use their money to grow, so they usually don’t pay dividends.
- Growth companies often have high price-to-earnings ratios, meaning investing in them can be more expensive than other stocks.
Strategy 3: Momentum Investing
Momentum investors go with the flow. They believe that winners will keep winning and losers will keep losing. They aim to buy stocks that are going up in price. They might also decide to sell short those stocks they think will keep dropping.
These investors heavily rely on technical analysis. They use data to guide their trading decisions and look for patterns in stock prices.
Momentum investors go against the efficient market hypothesis (EMH). This idea says that asset prices already reflect all available public information. However, momentum investors think that despite this, there are still significant short-term price changes to come because the markets aren’t fully reacting to recent company changes.
Despite some downsides, momentum investing has its advantages. For example, the MSCI World Momentum Index has averaged annual gains of 10.75% since it started in 1994, compared to 7.59% for its benchmark over the same time.
Who Should Use Momentum Investing?
Traders who follow a momentum strategy must be active and ready to buy and sell quickly. Profits come over months, not years, unlike simple buy-and-hold strategies where you just set it and forget it.
Momentum investing also requires frequent technical analysis. It relies on data to decide when to enter and exit trades, and these decisions often change based on market sentiment. For those who don’t want to monitor the market daily, there are exchange-traded funds (ETFs) that follow momentum-style investing.
Because it’s highly speculative, momentum investing is one of the riskiest strategies. It’s best for investors who are comfortable with the possibility of losing their capital, as it’s similar to day trading and has the highest potential for losses.
Pros and Cons – Momentum Trading
Pros
- With higher risk comes the potential for higher rewards, especially in the short term with momentum trading.
- Momentum trading happens quickly, so you don’t need to invest for long periods.
- This type of trading is simpler because it focuses on immediate factors rather than long-term trends.
- Momentum trading is often the most thrilling way to trade. With rapid shifts in price, it’s much more engaging than strategies that involve holding onto investments for the long term.
Cons
- Momentum trading needs a lot of skill to judge correctly when to enter and exit trades.
- Momentum trading depends on market changes; good trades may not be available if prices don’t move quickly.
- Depending on your investments, there’s a higher risk for short-term gains.
- Opportunities in momentum trading can vanish suddenly, leaving traders with no chance to buy or sell at the desired points.
Strategy 4: Dollar-Cost Averaging
Dollar-cost averaging (DCA) is a smart way to invest regularly over time, and it works well with other investment strategies. For example, you might put $300 into your investment account monthly with DCA.
This method is even better when you use automated tools that invest for you. DCA helps you avoid the risky strategy of trying to time the market. Sometimes, investors try to buy when they think prices are low, only to realize later that prices can drop even more.
With DCA, you invest the same amount regularly, regardless of high or low prices. This helps lower the average cost of your investments over time and can reduce the taxes you owe when you sell your shares in the future.
Who Should Use Dollar-Cost Averaging?
Dollar-cost averaging is smart for most people who want to save and invest. It helps reduce the risk of investing a large sum at once and minimizes the impact of market ups and downs. Many investors don’t have much money to invest in one go, so using dollar-cost averaging is a way to invest regularly over time.
This approach also helps counteract common human biases that can affect investment decisions. For example, we tend to feel losses more strongly than gains and often pay more attention to information confirming our beliefs.
To use dollar-cost averaging effectively, you must have a steady income and some extra money to invest regularly. Many online brokers offer options to set up automatic deposits on a schedule that works for you. You can adjust this schedule if your financial situation changes or you want to change your investment strategy.
Pros and Cons – DCA
Pros
- Dollar-cost averaging can be used with the other investment strategies we’ve discussed. It’s a flexible approach that can complement different investment techniques.
- When prices are decreasing, dollar-cost averaging lowers your average purchase price. This means you could make more profit in the future.
- Dollar-cost averaging removes the emotional side of investing by making regular investments no matter how the markets perform.
- Once established, dollar-cost averaging can be very hands-off and need little upkeep.
Cons
- Once established, dollar-cost averaging can be very hands-off and need little upkeep.
- When prices go down, your average investment cost decreases, which could lead to higher taxes in the future.
- You need consistent and reliable cash flow to invest using DCA.
- Investors might feel they don’t need to monitor their DCA strategies, but reviewing investments regularly is important, even if they’re automated.
Once You’ve Identified Your Strategy
If you’ve picked a strategy, that’s a good step! But before you start investing, there are some things to do. First, figure out how much money you need to start and how much you can keep investing.
Decide how you want to invest. Will you use a traditional financial advisor or a worry-free robo-advisor?
Think about your investment options. Cash accounts let you take money out immediately but may have big risks. 401ks are for retirement, and your employer might match your contributions. Different IRAs offer different options.
Stay diversified. Spread your investments across stocks, bonds, mutual funds, and more to lower your risks. If you care about social issues, consider responsible investing.
Decide what you want your investments to be and how you want them to look.
Important: When deciding on your investment plan, consider these questions:
- Are you aiming for short-term or long-term investments?
- Do you prefer investments you can easily access or ones that are harder to cash out?
- Are you willing to take on more risk for higher returns, or do you prefer to avoid risk for stability?
- Do you prefer to handle your investments or hire a financial advisor?
- Would you like to regularly keep track of your investments or take a more hands-off approach?
- Would you prefer to invest small amounts gradually or make a large investment all at once?
1. What Is the Best Investment Strategy?
Ans: The ideal investment strategy aligns with your financial objectives. There isn’t a single strategy that fits everyone’s needs. For instance, momentum trading suits those seeking fast profits despite higher risks. On the other hand, value stocks are more suitable for long-term planning.
2. How Do I Set Up an Investment Strategy?
Ans: Creating an effective investment strategy starts with setting clear long-term goals. Determine how much money you aim to save, your timeline for saving, and what you want to accomplish financially. Once you have your goals, you can set targets for returns and savings and then identify assets that align with your plan.
For instance, if your goal is to save $1,000,000, you might need to invest $10,000 annually for 29 years and aim for 8% annual returns to reach that target. With this information, you can explore historical investment performances to find asset classes that match your strategic objectives.
3. How Do Beginners Invest in Stocks?
Ans: New investors can begin with stocks by depositing money into a low-fee or no-fee brokerage firm. These firms won’t charge much (or anything at all) when you deposit, trade, or take out funds. In addition to using a brokerage firm, you can use the information on their website to research which types of investments and securities you’re interested in.
The Bottom Line
Deciding which strategy to use is crucial, even more so than the strategy itself. Any of these strategies can lead to good returns if you decide to stick with it. Starting early is key because compound interest grows over time.
Remember not to only look at yearly returns when picking a strategy. Choose the one that fits your timeline and how much risk you’re comfortable with. With a clear plan and goal, you’ll be on the path to a successful investing journey!
Buy, trade, and hold 350+ Currencies.
Join over 120 million registered users to trade the most popular cryptocurrencies in the world. Buy and sell Bitcoin, Ethereum, or Binance’s coin, BNB, with low fees on Binance. Whether you’re new to trading, a crypto fan, or an expert, you’ll have access to global crypto markets. The Binance app offers tools and guides to help you safely and securely trade, buy, and convert NFTs.
