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Why and How to Start Investing

Views 240KNov 1, 2023

Common investment strategies

Key Takeaways

  • Value investing generally requires investors to remain in it for the long term, and do careful research before stock selection.

  • Investors who follow growth strategies want investments that offer substantial upside potential when it comes to the future earnings of stocks.

  • Momentum investing is a strategy that aims to capitalize on the continuance of existing trends in the market.

  • Dollar-cost averaging is the practice of making regular investments in the market over time.

Here, we look at four common investing strategies that suit most investors. By taking time to understand the characteristics of each, you will be in a better position to choose one that's right for you over the long term.

Value investing

Value investors are bargain shoppers. They seek stocks they believe are undervalued, with prices they don't think fully reflect the stocks' intrinsic value. Value investing is focused, in part, on the idea that some degree of irrationality exists in the market. The irrationality, in theory, presents opportunities to get a stock at a discounted price and make money from it.

Russel Kinnel, director of fund research at Morningstar explained, "Over the decade ended December 31st, 2012, value funds specializing in large stocks returned an average of 6.7% annually. But the typical investor in those funds earned just 5.5% annually."

Why did this happen? Because too many investors decided to pull their money out and run especially in 2008. The lesson here is that you must play the long game to make value investing work.

But if you are a true value investor, you don't need anyone to convince you to stay in it for the long run because this strategy is designed around the idea that one should buy businesses, not stocks.

People often cite legendary investor Warren Buffet as the epitome of a value investor. Warren Buffett once said: "Price is what you pay. Value is what you get." He does his homework, sometimes for years. But when he's ready, he goes all in and is generally committed for the long run.

Growth investing

Rather than looking for low-cost deals, growth investors want investments that offer substantial upside potential when it comes to the future earnings of stocks. It could be said that a growth investor is often looking for the "next big thing." Growth investing, however, is not a reckless embrace of speculative investing. Instead, it involves evaluating a stock’s current health and growth potential.

A growth investor considers the prospects of the industry in which the stock thrives. For example, you may consider if the future is bright for electric vehicles before investing in the sector, or if AI will become a fixture of everyday living before investing in a technology company. There must be evidence of a widespread and robust appetite for the company's services or products if it's going to grow. Investors can answer this question by looking at a company's recent history. To put it in simple terms, a growth stock should be growing. The company should have a consistent trend of strong earnings and revenue, signifying a capacity to deliver on growth expectations.

A drawback to growth investing is a lack of dividends. If a company is in growth mode, it often needs capital to sustain its expansion, which doesn't leave much (or any) cash for dividend payments. Moreover, with faster earnings growth comes higher valuations, which are a higher risk proposition for most investors.

Momentum investing

Momentum investors ride the wave. Momentum investing is a strategy that aims to capitalize on the continuance of existing trends in the market.

Momentum investing involves going long stocks, futures, exchange-traded funds (ETFs), or any financial instrument showing upward-trending prices and short the respective assets with downward-trending prices.

Momentum investing holds that trends can persist for some time and that it's possible to profit by staying with a trend until its conclusion, no matter how long that may be.

Momentum investing usually involves abiding by a strict set of rules based on technical indicators that dictate market entry and exit points for particular securities.

Momentum investors sometimes use two longer-term moving averages (MAs)[1], one a bit shorter than the other, for trading signals. Some use 50-day and 200-day MAs, for example. In this case, the 50-day crossing above the 200-day creates a buy signal, while a 50-day crossing back below the 200-day creates a sell signal. A few momentum investors prefer to use even longer-term MAs for signaling purposes.

Dollar-cost averaging

Dollar-cost averaging (DCA) is the practice of making regular investments in the market over time, and is not mutually exclusive to the other methods described above. Instead, it is a means of executing whatever strategy you choose. 

With DCA, you may choose to put $300 in an investment account every month. This disciplined approach becomes particularly powerful when you use automated features that invest for you. It's easy to commit to a plan when the process requires almost no oversight.

The benefit of the DCA strategy is that it avoids the painful and ill-fated strategy of market timing. Even seasoned investors occasionally feel the temptation to buy when they think prices are low only to discover, to their dismay, there is still a long way to drop.

Dollar-cost averaging is a wise choice for most investors. It keeps you committed to investing and can help reduce the risks associated with the market.

When investments happen in regular increments, the investor captures prices at all levels, from high to low. These periodic investments effectively lower the average per-share cost of the purchases. Putting DCA to work means deciding on three parameters:

  1. The total sum to be invested

  2. The window of time where the investments will be made

  3. The investment product you will invest in

Dollar-cost averaging (DCA) does not ensure a profit and does not protect against loss in declining markets. It involves continuous investing regardless of fluctuating price levels. Investors should consider their ability to continue investing through periods of fluctuating market conditions.  

Successful investing is not winning the lottery. It is finding a proven strategy that has worked for millions of other individuals throughout history and sticking with it. The good news is that more than one strategy works; you just need to find the one that you can stick with over a lifetime and make it work for you.

The decision to choose a strategy is more important than the strategy itself. Indeed, any of these strategies can generate a significant return as long as the investor makes a choice and commits to it. 

Remember, don't focus exclusively on annual returns when choosing a strategy. Engage the approach that suits your schedule and risk tolerance. 

[1]Moving Average (MA) is calculated by adding the closing price of a stock or other security over a specific period of time and dividing the total by the appropriate number of trading days.

Disclaimer: This content is for informational and educational purposes only and does not constitute a recommendation or endorsement of any specific investment or investment strategy.

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