As with most things in life, we each have our own style or approach to things based on what works, what doesn’t work and what fits in with our goals. It’s the same with investing. There are various investing styles and strategies that people use to achieve their investing goals and with time and experience people figure out which works best for them. In this article we are going to introduce you to four of the most commonly used investing styles, so as a new investor, you can figure out which resonates best with you.
Income investing, put the work in on the front end, then watch the money flow in
Income investing is focused on buying investments which generate a passive cash flow. As long as you hold the investment, you will earn income whenever it makes a payout. An example of this is dividend investing. This is an investing style where you buy stocks in companies that pay out a dividend to their investors on a regular basis, this could be monthly, quarterly or annually. As a company’s profits grow, rather than investing all of their profits back into the company, they reward their investors by paying out a cash amount per every share that the investor holds (this is called a dividend). So, if you own 10 shares of a company’s stock and they are paying a dividend of $0.90 per share, you will receive a cash payment of $9 just because you hold those shares. If the company pays a dividend multiple times per year, your investment is working for you by generating regular income based on the number of shares you hold.
Growth investing, see the potential and let your futuristic vision kick in
Growth investing is focused on buying shares in companies that have good growth potential. These are often smaller or younger companies which are innovating or developing in growing industries. They are companies which seemingly haven't maxed out their potential and you believe have the ability to become much bigger and more valuable than they are today. With growth stocks you are investing in your conviction that the value of the stock will increase significantly over time, hence the price of the stock will go up, therefore you are benefiting from buying while the stock price is still relatively low. Growth stock companies often don’t pay out dividends, but they rather reinvest all profits back into the company to accelerate its growth. A lot of the newer tech stocks fall into this category and as an investor, although a riskier investment, you are investing into what you believe to be their future potential.
Passive investing, put multiple eggs in one basket and let diversification work its magic
Passive investments are a great foundation for any investment portfolio. As a new investor you will have likely heard of index funds. Index funds are a portfolio (a basket) of stocks or bonds which match or replicate the composition or performance of a financial market index. Rather than having to research and hand pick which individual stocks to invest in yourself, a professional portfolio manager buys a portion of all the stocks which make up a particular index and creates a fund. If we take an index fund which tracks the S&P 500, you are buying into a fund which comprises of a proportion of the stocks of the top 500 companies in the U.S. which make up the S&P 500 index. When you buy shares in that fund you own a small fraction at a lower cost than if you had a portfolio manager actively buying and selling individual stocks for you on a regular basis. Not only are you getting access to a broad range of companies through a single fund, but you are also reducing your risk, because if one companies within the index is not doing so well, you have many others which will be.
Alternatives to index funds are funds which focus on a particular industry or category. So, you could buy shares in a fund which consists of numerous companies focused on the healthcare industry, or international companies, or clean energy companies. There are thousands of funds on the market, so it is likely that you will find one which corresponds with your interests.
Value investing, tap into the value when others can’t see it…yet
Value investing is a strategy where investors seek to buy individual stocks in companies that the investor believes are great companies but are currently undervalued. It is a strategy which requires a deep understanding of the economics of the business, or maybe as a consumer of the product, a belief that it is a great company, product or service which is well managed and is not yet appreciated for its actual potential. As an investor, you are buying on the basis of a low price now, you will hold it for the long term while you wait for the market to correct and drive it up to its true price value. Value investing may not be ideal for someone who is new to the financial markets. However, even as a new investor, you may have one or two stocks in your portfolio for products that you personally use and trust; you genuinely believe that in the long term the price will increase to reflect the quality of the company behind the product.
In this article we have just focused on four strategies, but there are so many more. You don’t have to choose only one and stick with it, you might decide to incorporate various strategies into your investing style and build on it as you gain more experience.
Every strategy has its pros and cons, so when weighing up your options, keep these tips in mind.
Income investing is hugely popular because many investors like the regular flow of income generated by the dividend paying stocks, but keep in mind that earnings from divdends will be subject to tax and also, if a company is paying out large dividends, this is money that they are not reinvesting to grow the business. So, avoid falling into the trap of targeting only companies paying high dividends; as an investor you want to put your money into companies which are reinvesting into their development and also have the potential of longevity.
Growth companies can supercharge the fortunes of investors who get in early, just think of how wealthy you would be if you'd invested in companies like Amazon, Google, Apple, Netflix and others when they went public? But with that, keep in mind that there are hundreds of other companies which went the opposite direction, failed and lost their investors a lot of money. No matter how experienced financial experts claim to be, no one has a crystal ball, so if you choose to focus your investments in individual growth companies, make sure that you are doing so based on a good understanding of these businesses or their industries. Alternatively, you could opt for a safer option and invest in a fund which is targeted at growth companies.
That’s the perfect opener to talk about funds which are a great foundation to your investment portfolio, particularly if you are starting out. While funds give you great exposure to many companies in one basket, keep an eye on the expense ratios and fees charged to invest in the fund. You don’t want the fees charged by the fund to unnecessarily eat away at your returns in the long term.
If value investing sounds more like your thing, make sure that you are going on more than just a hunch. Warren Buffett has famously made his wealth as a value investor, but Warren Buffett also famously spends 80% of his day reading and absorbing new information. Passion and educated insight drive the value investor and their belief in what they can see that others have not…yet. It is a risky strategy but can pay hugely if you get it right.
Whichever strateg(ies) you choose, don’t forget why you are doing this. It’s not because you are following the hype or jumping onto the hottest new “get-rich” stock. You're investing to become a part owner in a company or an industry. You’re interested in the businesses and believe they are managed well, are creating the best products and services, and over time will continue to grow in value and ultimately build your wealth.
You don’t need to be an expert to start investing, but understand that however small, your money has power - by investing you are aligning yourself with companies or industries that will shape our future world.
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