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The complete guide to investment strategies 2017.
When I started investing, I knew nothing about investment strategies - I dived straight in.
I liked the idea of holding stocks and shares but had absolutely no clue on what to buy, when to buy or even how to buy.
Reading about investment strategies just seemed like too much work!
So I just bought what I thought was good without any research.
This was a bad move, like building a house without planning or starting a diet without a meal plan.
I lost 50% of my first investment.
In 2013 I bought £1,000 worth of shares in Gazprom, a russian gas company, because I saw it recommended somewhere.
A few months later my precious £1,000 has halved to £500 and I felt sick to the stomach.
At 18 I didn't have much money and here were my savings crashing before my eyes.
But, this turned out to be the best investment I ever made.
Despite being down 50% it motivated me to actually research stock market investing and investment strategies.
In this article I'm going to save you the pain of such stupid mistakes by breaking down investment strategies, step-by-step in plain English.
All the investment strategies noted in this article will be rated 'green', 'amber' or 'red' for both ease of use and safety. Please note that all ratings are my own opinion,
Some of these strategies are for short term holding periods and others for the longer term. These investment strategies can also be combined. I myself am a value and dividend investor.
Enough of the rambling - Let's get stuck in!
A word on investing and diversification
If you've already researched the importance of diversification and why it is one would want to invest in the stock market then you can safely skip this paragraph by using the table above to skip to 'Value Investing'.
Why Invest?
Before tackling investment strategies it's important we ask ourselves why we want to invest. After all, investing is risky, especially when compared to holding cash in an interest paying bank account.
Most people looking to invest are simply fed up with the dire interest rates on offer from bank accounts. You'll be lucky to find something above 2% in the UK, unless you commit to locking up your money for up to 5 years.
On the other hand, the average return of the FTSE All Share over the last 100 years is 7+%. The initial appeal of investing is therefore quite obvious - to make money!
Despite being told year after year that interest rate rises are on the way, the Bank of England has in fact cut the base interest rate further to a tiny 0.25%. With Brexit yet to be negotiated, it could be years until bank accounts offer anything appetizing to savers.
Another reason to invest in the stock market, especially for retirees is the income offered by dividend stocks. Many older people in society simply want to gain a reliable income from their savings and investing in high quality dividend stocks is one way to achieve this. Some skilled high yield investors can even achieve an income of over 10%.
But be warned, these returns come at a cost - your money is at risk!
Diversification
The stock market can be a scary place with wild swings upwards and downwards. Invest in the wrong manner and you could be in serious financial dire straights.
Diversification is key both in terms of the investments you hold and into where you invest your money.
Investors should never invest 100% of their capital into the stock market unless they're comfortable with a 100% loss. Wise investors should always spread their money across bank accounts, bonds, stocks and funds (not an extensive list). The exact split is up to you as an investor.
Very conservative investors will hold most of their money in bank accounts whereas the more enterprising investor will seek to hold most of his/her money in stocks.
Myself? As a 24 year old with no major commitments I can afford to take on a high degree of risk. I hold 6months worth of expenses as cash with every other penny going invested in the stock market.
On top of diversifying where to invest money, one should always further diversify within those investments, especially the stock market.
For example, it would be foolish of a stock market investor to hold 100% of his/her stock market investments in one stock - that's just asking for trouble. Pinning your hopes to one company is a very bad idea. As well as investing in different stocks, one should invest across a range of different sectors. There are more risky sectors such as technology and less risky sectors such as healthcare. Again, the mix sectors selected depend on an investor's risk tolerance.
For a further explanation on the importance of diversification - Investopedia have written an in depth article covering the matter.
If in doubt - always seek independent financial advice.
1
Value Investing
Relatively high learning curve when it comes to valuation methods
Purchasing shares at below market value provides a margin of safety on investments.
Value investing has become less popular since the financial crisis but there are still many die-hard value investing fans out there. This may be due to the success of one of the world's most prolific value investors, Mr. Warren Buffett.
So what is Value Investing?
Put simply, value investing is the purchasing of stocks below their intrinsic value. Intrinsic value is the posh way of saying the company's underlying value and it's measured in many ways, for example;
- Price to earnings ratio
- Price to book ratio
- Ability to generate a high Free Cash Flow
- Economic moat
Value investors believe that the market can severely overreact to bad news that will affect a company over the short term. But, value investors take a long term view on any company and somewhat welcome bad short-term news if it presents a buying opportunity, especially when a company's fundamentals remain solid.
But be warned value investing is certainly one of the investment strategies more suited to patient long term investors - if you're going to go down the route of value investing you must be very patient and should ideally seek to hold shares for at least 5 years if not forever. You often need to be prepared to see your investments fall before things get better.
2
Momentum Investing
There's a need to learn about moving averages and trend lines in order to implement this strategy.
Ignoring stock fundamentals is asking for trouble!
Momentum investing is pretty much the opposite of value investing. Momentum investors seek to take advantage of existing market trends and upturns, usually in specific industries and 'fads'. Momentum investors seek to temporarily hold stocks before selling at a higher price or short stocks that have a downward momentum.
The basic idea of momentum investing is that once a trend takes hold of a stock, it is more likely to continue in that direction than to move against the trend.
Whereas value investing looks at a company's fundamentals, momentum investing may use a series of 'charting' or 'technical analysis' techniques in order to determine a stock's future direction. Momentum investors focus mainly on trend lines and moving averages with the hope of predicting the future upwards or downwards movement of a stock.
Example of a 'trend line' from StockCharts .com
If technical analysis indicates a future uptrend, the stock is bought and then sold at a higher price in the future.
If technical analysis indicates a future downtrend, the stock is 'shorted'.
Personally, I'm not a fan of momentum investing as it's based largely on opinion, market appetite and trend lines as opposed to the underlying value of the business and its actual operation.
The main downsides to momentum investing are;
- An ongoing need to pay trading fees
- Short-term holding periods increase the risk of capital loss
- More fundamental changes in a stock will easily break a trend
- You have to be very active in your research and activity
3
Growth Investing
Not as in depth as value investing but still requires strong knowledge on revenue growth, stock history and the industry moving forward.
A reasonable degree of fundamental analysis takes place but there is still a reliance on smaller companies in their growth stage.
Growth investing focuses on investor's capital growth (growing their money) by investing in so called 'growth companies' .
Growth companies are companies that are rapidly growing their earnings above those of the wider market. As such, a growth investor's main focus is the future potential earnings of a company its average historical earnings growth.
As opposed to value investing, growth investors are more ready to invest in stocks with a higher p/e ratio in the hope that earnings will keep increasing at a rapid pace. The idea here is that an investor's purchase price to earnings ratio would drop to a reasonable level within a few years.
For example, if a company has a p/e ratio of 50 when you buy and it doubles its earnings within 5 years, your purchase price to earnings ratio would be 25.
Many growth investors focus on smaller cap companies (although not exclusively), up and coming industries and emerging markets.
The main risk of growth investing is that a company's growth can easily stall and many growth stocks suffer large one-day drops off the back of the slightest hiccup.
You'll usually find growth stocks in the smaller indexes such as the FTSE350 and the AIM as opposed to the FTSE100 which is full of more mature companies.
4
Technical Analysis
Very high learning curve with the need to learn many stock patterns, A large degree of experience and practice is needed for real-time trading.
No fundamental analysis undertaken, no evidence that technical analysis patterns are accurate and relatively short term positions taken.
Although many 'momentum' investors employ technical analysis methods, there is such thing as 'pure' technical analysis investing.
Technical analysis investing is more diverse than momentum investing as there's a series of patterns aside the trend line and moving averages that momentum investors rely on. These include alleged 'head and shoulders', 'reverse head and shoulders', 'wedge', 'cup and handle' and more.
Technical analysis is almost exclusively used for trading as opposed to investing and it's important that cautious investors stay well away.
Technical analysis advocates believe that by identifying stock chart patterns early on they can successfully identify the future movement of a stock or commodity and buy/short accordingly.
Technical analysis has been widely criticised for its countless patterns and accuracy. In my personal experience, I have no confidence in technical analysis methods whatsoever as identified 'patterns' are constantly changed in retrospect and the investing method has no regard for a stock's underlying fundamentals
5
Index Fund Investing
A very simple investment method. A monthly investment into a S&P 500 index is all that is needed (although many investors diversify a small amount of their portfolio into emerging market index funds which are more risky)
Over the long term, the small fees and very large diversification of index funds make them a very safe long term investment - although your money is still at risk! Be sure to still invest over a series of asset classes though - not just the stock market.
The world's most famed investor, Warren Buffett has said that Index fund investing is the investing strategy that makes
'the most sense practically all of the time'.
His advice for the average investor is to invest consistently in a low cost S&P 500 index fund.
The main argument in favour of index funds are;
- They consistently outperform managed funds
- They charge very low management fees (as low as 0.15%)
- Very little stock market knowledge is needed before investing
- Large diversification quickly thus drastically reducing risk.
Index funds consistently outperform managed funds due to the high fees charged by fund managers. For example, a fund charging a 1.5% management fee would need to outperform the market by 1.5% just to end the year even with the market - evidence suggests that this doesn't happen! In reality, the likelihood of a fund manager consistently outperforming the market +1.5% year on year is surprisingly slim.
Index investing is certainly a boring and mechanical form of investing but it's one of the, if not the, safest investment strategy out there. Those investing in a 80/20 split of mature and emerging markets won't go far wrong in the long term.
The main argument against index fund investing is that investors lose a lot of control over where they invest their money and could miss out on potential above market returns of certain stocks or fund managers.
6
Dividend Growth Investing
A lot of research is needed in order to determine the long sustainability of a dividend. Diversification across sectors is essential - It's important to note that a company's dividend history isn't necessarily an indication of its ability to grow its dividend moving forward.
The income generated by dividend growth investing enables an immediate income and benefit from the stocks. Dividend growth investing is a very long term strategy and as such the risks are much smaller than more short term investment strategies. You really have to know what you're doing though!
Put simply, a dividend is a payment made by a company to shareholders as a thank you for holding their stock.
Dividend investors seek to buy stock in these companies that pay dividends in order to generate an income from the dividends they receive. On top of this, dividend growth investors also seek to identify and purchase shares in companies that have consistently grown their dividends over many years. The theory is that robust, large companies at the right price will provide a steady stream of income well into retirement.
The main advantage of dividend investing is that you can get an immediate return on your investment without the need to sell! The vast majority of dividend investors also reinvest their dividends to buy more shares in order to receive more future dividends. Here's how compounding works;
The main argument against dividend growth investing is that most companies that pay dividends are simply unable to generate better returns through investing that cash internally. As a result, dividend investors may miss out on rapidly growing stocks that don't pay dividends as they can get a better return on their cash by investing it internally in growth, expansion and innovation. Dividend growth investing also requires a lot of time researching stocks in order to determine the sustainability of a dividend going forward.
Although not essential to dividend investing, many dividend investors combine this strategy with value investing in order to purchase undervalued dividend growth stocks. This provides room for capital growth and for dividend income.
If you're interested in dividend investing then I recommend you follow my blog as I am a dividend investor.
7
Dividend Yield Investing
A stock's high yield is usually an indication of the stability of a dividend. The higher the yield, the higher the chances of facing a dividend cut or capital risk. A Dividend Yield investor's art is to find high yielding stocks that can sustain their dividend. That's not easy.
If you stick to larger companies, the risk of dividend yield investing can be reduced drastically. I really don't recommend investing in smaller high yielding stocks - that's asking for trouble. But beware, dividend yields are usually high for a reason and it's pretty easy to get your fingers burned.
Dividend yield investing is similar to dividend growth investing apart from one key aspect.
Where dividend growth investors look for companies that have the ability to continually grow their dividend, dividend yield investors are simply looking for the companies with a higher starting dividend yield.
This means that they're looking for high income - pronto!
An important rule of thumb to remember, albeit obvious is that companies that have a low starting dividend yield but grow their dividends at high rates will eventually pay out much higher dividends than companies that have high starting yields but rarely grow their dividends.
As such, most dividend yield investors are those who are looking for high income in retirement and most dividend growth investors are younger investors who are looking forward to the magic of compounding.
Screengrab from Google
A good example of a stock prime for a dividend yield investor would be ARLP (Alliance Resource Partners, L.P), a coal company.
Now, obviously coal has a very perilous future with declining use and an increased focus on green technologies.
As a result, investors have fled this coal company and as a result it sports a dividend yield of nearly 10%!
With very little room for growth in the future and probable dividend cuts, this stock wouldn't suit a young investor but is still fit to pay out 10% dividend to those looking for income.
The main problem with dividend yield investing is that it's inferior to dividend growth investing in the longer term. High dividend yields are also an indication of an imminent dividend cut so investors need to be very careful when selecting dividend yield stocks for investments.
8
Managed Fund Investing
Although picking the right fund can be difficult, fund platforms often offer enough literature for investors to be able to make reasonable decisions. After purchasing a fund, in theory, little action needs to be taken thereafter, making this one of the easier investment strategies.
Although managed funds often outperform index funds, it's reassuring that professional managers are managing the money in managed funds. Over the long term money invested in most managed funds is safe, even if your fund underperforms the wider market.
From my conversations, this would appear to be the most popular form of investing amongst your average Joe in the UK at present.
Fund Manager Neil Woodford - Photo credit: bbc.co.uk
Managed fund investing is simply purchasing funds (a collection of stocks) that are then managed by a fund manager. One of the most popular UK fund managers is Neil Woodford who runs the CF Woodford Equity Income fund that's constantly being plugged by ThisIsMoney and HL.co.uk.
The idea behind managed fund investing is that professional fund managers know what to do with your money and they have the ability to deliver above market returns. But, as discussed in item 5 above, this usually isn't the case over the long term.
The main drawback of managed fund investing is that managed funds charge substantial fees that, compounded over decades, can really drastically eat away at your gains.
But, on the other hand, you don't have to pay to buy and sell funds on most platforms (as you do with shares) and many people feel a lot more comfortable having someone else make their investment decisions for them and if you're lucky you may just invest in a fund that will go on to smash the market year on year.
Woodford CF Equity Income's top holdings. Taken from HL.co.uk
9
Ethical/Socially Responsible Investing
Ethically/Socially responsible investing can be a mix of one or more investment strategies, is is therefore difficult to give it a ease of use score.
Ethically/Socially responsible investing can be a mix of one or more investment strategies, is is therefore difficult to give it a safety score.
Investing is often viewed in a negative light. Thanks to the 2008 market crash many people assume that stock market investors (even poor students like me) are immoral, profit chasing robots with little emotion.
Due to this along with moral concerns many people are now shifting away from investing in your so called 'sin stocks' and 'sin industries'. These include Tobacco, Oil, Gambling and so on. Moral concerns have now become so pronounced that more or less any company can be considered a 'sin stock' by some.
This has given rise to a new form of investing dubbed 'ethical' or 'socially responsible' investing where investors seek to specifically invest in ethical funds, co-operatives, community ventures and green technologies.
There are now a variety of funds geared directly towards these goals and principles such as Standard Life Investments UK Ethical for example.
My main issue with this type of investing is that the definition of 'ethical' is pretty flexible and subjective.
For example, see right (or below of mobile) for the top 10 holdings of Standard Life's UK Ethical fund.
Most investors would certainly be surprised to see big names such as Vodafone in the top investments and the distinct lack of green energy companies.
A more 'pure' ethical investment funds are also restricted to smaller, more risky companies and are unable to benefit from the stability and generous dividends paid out by stocks such as Altria Group (tobacco) and Exxon Mobil (Oil).
10
Contrarian Investing
Although contrarian investing appears simple, it takes a lot of time and research to identify stocks and industries that have been unreasonably punished.
I'm a big fan of contrarian investing as there's often great value present. This gives an investor a great margin of safety on a stock - but - an investor can easily find themselves in a stock or industry that will never turn a corner.
Contrarian and value investing overlap somewhat and as such are naturally aligned.
The main focus of contrarian investing is to essentially bet against the market consensus on a certain stock or sector. Many recent contrarian investments have been in the retail space as retail companies have really had a tough time competing against the rising online-only stars (ASOS and Booho for example).
Contrarian investors rely mainly on two things;
1. Market doomsdayers and sensationalists that dub stocks and industries 'dead in the water' thus driving away investors from perfectly well functioning companies facing short-term headwinds.
2. The ability of management to adapt.
Alexander Mamut - The man who transformed Waterstones
My favourite example of contrarian investing would be Alexander Mamut's purchase of Waterstones (the bookstore) in 2011 for £53m.
This was against a backdrop of doomsday predictions of the demise of the physical book industry due to the rise of e-readers and audio books.
But, despite the e-reader initially gripping the market, Mamut managed to carve out a niche for Waterstones by re-aligning the company to show the value of paper and hardbacks over their digital counterparts.
As it happened, e-readers failed to takeover the market as many industry 'experts' had predicted and in April 2016 Waterstones turned its first profit in 7 years (£11.7m), 1/5th of the sale price!
Investors can do the same by buying shares in apparently 'doomed' industries that they feel will turn a corner. (Ahem! Retail)
11
Copycat Investing
Copy cat is one of the easiest investment strategies - you simply copy the trades of others!
Classic copycatting is relatively safe if you're following the likes of Buffett - But be aware of the large fees you'll face if you're actively buying and selling stock.
Modern copycatting is very dangerous - these people aren't investment experts and platforms have a bad habit of only advertising the success.
The more classic concept of copycat investing is the 'strategy' of simply copying the world's most successful investors.
Many people opt to check out Berkshire Hathaway's (Warren Buffett's holding company) 13F filings (declarations of top holdings) and to buy/sell accordingly in the expectation that Buffett is doing the right thing due to his decades of success. The main drawback to copycatting in such a way is that by the time Buffett's 13F is released the stock's predicament has already changed.
A more modern form of this investment strategy is to follow the tips of stock 'gurus' or to sign up to platforms such as eTorro and to copy the trades of the platforms most successful traders.
Screenshot from eTorro's website.
The idea here is that by following Conhoulihan's trades you could be set to make a handsome few bucks in the coming months!
The biggest problem with this more modern form of copycat investing is that these 'social' platforms tend to charge large fees and that they also have a tendency to only show the most successful traders.
We must also remember that everyone's set of circumstances is different and copying another investor is very unlikely to suit your own personal circumstance.
Anyone considering copycat investing has to remember one key market caveat
"Past performance is not an indicator of future performance"
12
Robo Investing
Robo investing was designed to be easy!
You simply answer a series of questions and the platform will do the rest for you.
Robo investing platforms spread are designed to meet the needs of your risk tolerance and to offer instant diversification across a series of asset classes (bonds and cash for example). This is one of the safest investment strategies - leave it to a computer!
Robo Investing is becoming more and more popular as many think that it delivers an acceptable balance between managed fund investing and index investing.
You get the ability to immediately diversify your holdings without having to research specific funds simply by dragging a slider. Here's how it works on Nutmeg, one of the most popular robo-investing platforms;
Robo investing platform's fees tend to be pegged at around 0.45% plus the cost of the index funds giving a usual annual investment charge of around 0.6-0.8%. Whilst this is still lower than the 1% + charged by most managed funds it is also above the 0.15% you could be paying by selecting the index funds yourself.
In it's purest form, a robo-advisor is simply a computer programme that adjusts the index funds it selects for you according to your answers to a series of questions.
The main advantages are that you really take away the stress of having to search high and low for the right funds to suit your circumstances but it's definitely something you could do yourself given enough research and time.
This is probably the method I'd recommend to those who are looking to start investing. If you're interested in this form of investing, I highly recommend you read my step-by-step guide here - Nutmeg investment review.
To close, I'd like to give a BIG shout out to UK Money Bloggers for helping me with this guide on investment strategies - kudos to them for the ratings concept and more.
I'd also love it if you could share my post. I don't display ads or affiliate links, my pleasure is my readership and I love it when people enjoy my content.
Lewys
3
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Just one more thing
I'm a full time student teacher and really work hard to put this content together to help more people understand investing. Investing is a passion to me and I'm really proud of the amount of people whom I have helped since starting this blog in 2014. I don't make a penny for this blog and I hope that you've enjoyed the ad-free and affiliate-free browsing expI would really appreciate it if you could give me a helping hand and share this content.
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