Once upon a time, legendary investor Baron Rothschild was asked the secret of his success; to which he supposedly replied: “I never buy at the bottom and I always sell too soon.”
Whether he actually said that or not, the comment speaks to the need to make use of a strategy to guide investing decisions. For our purposes, we can define strategy as a systematic plan of action to achieve a goal.
Today the Internet has made the process of searching for investment strategies relatively easy. You can spend hours learning the advantages of the buy and hold strategy. Legendary American investor Benjamin Graham and his star pupil Warren Buffet made fortunes with this approach to investing.
At its foundation, buy and hold relies on fundamental analysis as the tactic needed to implement the strategy. Some see fundamental analysis as a strategy in its own right, focusing on the inherent business value and soundness of a particular company.
Others rely on technical analysis, which focuses on price movements in the market as a whole as a strategy for buying and selling shares. Within this broad approach, there are hosts of indicators investors use as buy and sell signals. You can learn how to use MACD indicators, moving averages, head and shoulders patterns, and Fibonacci retracements.
If you have been searching the net for investing strategies you have probably run across top-down investing as well as bottom-up investing. There is value investing and growth investing. You know you can invest in managed funds, exchange traded funds, bonds, or individual shares. If you have already made the decision to concentrate on shares, what strategy is best for you?
There are strong proponents of fundamental analysis that feel any other strategy is speculating, not investing. There are strong proponents of technical analysis who claim the fundamentals of a company are totally irrelevant.
The truth is you can make money following any investing strategy, provided your approach is in fact a strategy involving more than throwing darts at a board. Here are four components of a strategy you need to know:
1. Investment Goals
2. Asset Allocation
3. Risk Tolerance
4. Buy and Sell Guidelines
Some investors scoff at the notion of being precise in setting out their investment objectives. When asked about investment goals, their reply is – “I want to make money!”
Well, we all want to make money, but how much is enough? And by when do we expect to need the money? Answers to these questions guide your choice of investing strategies.
If you are close to retirement, you are going to look for a less aggressive strategy than you would if you were just starting out in the work force. If you need the money you are planning to invest for a down payment on a home in the next few years, you are going to look for a strategy that seeks short-term gains rather than long-term stability. If you inherited $10,000 from a rich Uncle, you might look for a more aggressive strategy.
How much do you have to invest? Will you invest it all at once? If you have already done some homework you may know there is an investing tactic called diversification, which warns you not to put all your eggs into one basket. With $5,000 to invest, do you invest it all at once? Do you pick five shares and invest $1,000 apiece?
There is an investing tactic called dollar-cost-averaging that calls for investing specified amounts of money at specified times. The idea is to spread the risk of buying all the shares you can afford at a single price that may go down. With this strategy, you might invest $100 in each share on the 15th day of each month. Alternatively, you could buy 50 shares only when the share price has declined a minimum of 3-5% from the previous close. This is another investing tactic called buy on the dips.
For some investors, this is the most important component of their investing strategy. Risk tolerance is more than calculating how much of your investment you can afford to lose. It is really about the uncertainty involved in investing.
People with low risk tolerance have a hard time sticking with investments in shares that exhibit wild fluctuations in price over time. What’s more, there is some psychology involved here that makes certain investors experience more pain from a 20% drop in a share price than the pleasure derived from a 20% increase. If your temperament expects continuous upward movement in share price, you may be risk averse and should invest accordingly. If you are the type of person who would lose sleep at night over falling share prices, you are definitely risk averse!
In the coming weeks we will look at investing strategies both for the risk averse. Using managed funds as a means of getting diversification and dollar cost averaging to smooth out price fluctuations is an example of a risk-averse strategy.
Buy and Sell Guidelines
This is by far the most important component of any investment strategy. Most retail investors look to strategies like technical or fundamental analysis as a means to tell them what to buy. But what about not only what to sell, but more importantly, when to sell?
Here is the most important thing you need to remember about investing in the share market – you have not made or lost a single dime until you sell. The investment community is littered with the bodies of retail investors who never figured out a “paper” profits mean nothing. The question you need to answer for yourself is how will you know when to take your profits, or your loss, and sell.
In summary, there are a wide variety of investing strategies from which to choose. All have the potential to increase your initial investment. The real key is to select a strategy that matches your personal investment goals, asset allocation needs, level of risk tolerance, and buy and sell guidelines.