11 Effective Investment Strategies

Last Updated – Nov 17, 2023 @ 6:39 am

Choosing the best investment strategy involves a combination of understanding your financial goals, risk tolerance, investment horizon, and the current economic environment.

This guide aims to help you select an investment strategy that suits your needs.

What is an Investment Strategy?

An investment strategy helps an investor achieve their investment and financial goals. It is a plan based on the investor’s goals and risk tolerance, and it guides the investor in making investment decisions.

Ideally, an investment strategy is consistent and methodical. It can be conservative (the investor uses a low-risk strategy focusing on wealth protection) or highly aggressive (the investor focuses on capital appreciation with the aim of rapid growth).

Investment strategies can be used by individual investors to create their own portfolios or by a financial professional assisting an investor. It is important to note that these strategies are not static, so they have to be reviewed regularly, especially when circumstances change.

Components of an Investment Strategy:

1. Risk Tolerance: The level of variability in investment returns that an investor is willing to withstand. Risk tolerance can range from conservative to aggressive.
2. Investment Horizon: The amount of time an investor plans to hold an investment portfolio. A longer investment horizon often allows for taking on more risk.
3. Liquidity Needs: How quickly and easily an investment can be converted into cash to meet immediate and short-term obligations.
4. Diversification: Spreading investments across various financial instruments, industries, and other categories to reduce exposure to any single asset or risk.
5. Asset Allocation: The practice of dividing an investment portfolio among different asset categories, such as stocks, bonds, real estate, and cash.

Related Guide: How to Invest and Grow your Money

Types of Investing Strategies

In this section, we’ll look at the different strategies that investors utilize for maximizing profit and managing risk levels. 

1. Growth Investing

Growth investors look for investments that have good upside potential in terms of the stocks’ future earnings or the “next big thing.”

However, this does not mean that they recklessly embrace speculative investing because growth investing actually involves evaluating the current health of a stock and its potential for growth.

The industry where the stock thrives is also considered by growth investors. They look at its prospects. For example, before making an investment in a tech company, they will consider the possibility of A.I. becoming a fixture in people’s daily lives.

If a company is going to grow, there has to be evidence that the appetite for its products or services is widespread and robust. The company’s recent history should consistently show strong earnings and revenue. This signifies that the company can meet growth expectations.

A lack of dividends is a disadvantage of growth investing. Capital is often needed to sustain the expansion of a company that is in growth mode.

This means there is not much cash left to pay dividends. In addition, faster earnings growth is accompanied by higher valuations, which most investors consider a higher risk proposition.

2. Value Investing

Value investors want low-cost deals. They are bargain shoppers looking for stocks that they think are undervalued.

They believe that the security’s intrinsic value is not fully reflected in the prices of those stocks. Value investing is partly based on the idea that there exists a certain degree of irrationality in the market.

In theory, this irrationality provides opportunities to buy stocks at a discount and make money from them.

Finding deals does not necessarily mean combing through large volumes of financial data. There are numerous value mutual funds that allow investors to acquire stocks that are considered undervalued.

For example, value investors consider the Russell 1000 Value Index as a benchmark. Several mutual funds also mimic the index.

While investment strategies can be changed anytime, doing so can be costly, especially for value investors. With value investing, the long game has to be played.

Investors should not pull out their money after a couple of poor-performing years. Warren Buffet is often cited as a great value investor.

3. Passive Investing

This investment strategy involves keeping buying and selling to a minimum in order to maximize returns. A popular passive investing strategy is index investing.

Investors who adopt this strategy buy a representative benchmark like the Philippine Stock Exchange index. Then, they hold it for a long time.

In general, passive investing means buying and holding a portfolio for long-term investments. Trading in the market is minimal.

Related: Passive Income Ideas: How to Make Money While you Sleep

Compared to actively managed portfolios, passive investments cost less and are not as complex. In addition, passive investments often have better after-tax results over longer time horizons.

4. Active Investing

This investment strategy is a hands-on approach to investing and requires someone to act as the portfolio manager or an active participant.

The main goal of active investing is to take advantage of short-term price fluctuations. Because of its nature, this investment strategy requires a deep understanding of the market and a willingness to constantly monitor and adjust the portfolio.

The portfolio manager should be able to assess quantitative and qualitative factors that may impact the value of the assets in the portfolio.

One example of active investing is day trading. This involves buying and selling securities within a single trading day, taking advantage of small price movements.

It requires a high level of skill and knowledge, as well as quick decision-making abilities. Day traders often rely on technical analysis and charts to make their trades.

Active investing offers tons of advantages but also comes with considerable risks. For instance, you can exercise more trading options and try out hedging or shorting to beat market indices. You can also easily exit the market when needed.

However, prepare to pay higher fees in the long run since transaction fees can add up and impact returns.

Additionally, active investing requires a significant amount of time and effort since the investor needs to constantly monitor the market and make quick decisions on when to buy, hold, or sell.

Active investors may also be more inclined to follow market trends and buy meme stocks which can be risky.

5. Momentum Investing

Momentum investors like to ride the wave. They go for stocks that are experiencing an uptrend and may decide to short-sell the securities that are losing. They believe that winners will continue to win and losers will continue to lose.

As technical analysts, momentum investors use a trading strategy that is strictly data-driven. Patterns in stock prices guide their decisions when purchasing stocks.

Momentum investors basically go against the efficient-market hypothesis, which states that new information coming into the market is reflected in stock prices right away.

This is because momentum investing aims to capitalize on overvalued and undervalued equities.

6. Dividend Investing

Dividends refers to the money companies pay to shareholders. When you own stocks that pay you dividends, you will get a share of the company’s profit. Therefore, you can enjoy a steady stream of income in addition to the growing market value of your portfolio. 

However, not all companies pay a dividend. This is only common with publicly traded companies. To determine whether or not it’s a good strategy for a company to have dividends, they need to factor in different financial and economic elements.

Dividends are usually paid in the form of cash distributions monthly, quarterly, or yearly. 

To be given a dividend payout of any stock, you must meet the requirements. This can include being a shareholder of record on or before the date required by the company’s board of directors. 

Stocks can also be referred to as “ex-dividend.” If you buy this stock, you won’t be eligible to receive the current dividend payout, and you have to wait for the next one.

7. Income Investing

Income investing means selecting the best investments that will give you a regular source of income for a specific period. This is a common way to chase returns and beat inflation. It can come in the form of interest payments, dividends, and bond yields. 

The goal of this strategy is to help you build a portfolio filled with assets that will give you the highest annual passive income.

One of the best things about income investing is that anyone can try it. Because most companies have a large and stable income, they could help give investors a strong foundation for their portfolios.

With income investing, it’s recommended to shift your focus on overall returns instead of being caught up with short-term movements.

If your goal is to get income from an investment, do not factor in how the value of the asset fluctuates. If you’re receiving dividends, that will give you a reason not to panic especially if you plan on holding it until it matures. 

Whatever approach you follow with income investing, make sure to include a range of income sources in your portfolio that align with your timeline and risk tolerance. 

8. Indexing

This type of passive investment strategy involves compiling economic data into one metric, or comparing specific data to that metric.

Investors who use this strategy want to replicate the performance of an index by purchasing the component securities or putting their money into an Exchange Traded Fund, or index mutual fund. 

There are tons of indexes you can use to track index funds, and there are also different sector indexes that focus on specific industries, or country indexes that highlight value-priced stocks, and fast-growing companies in a specific nation. 

After you have chosen an index, find an index fund that tracks it. If you’ve chosen more than one index, try to see which index fund tracks the performance best, costs the lowest, and offers the least amount of limitations.

After this, you’re ready to buy shares in the index fund of your choice. To do this, simply open a brokerage account, or open an account with the company that offers the fund. 

9. Contrarian Investing

This investment strategy refers to purposefully going against the grain by selling when other investors are buying, and buying when other investors are selling. The principle of this strategy says that following the herd instinct that controls the market direction is not a great thing to do. 

Those who follow this strategy believe that people who say the market value is going down only say that because they have no purchasing power left.

Considering this, the market still hasn’t peaked. When the price rises, these investors have already sold out their shares.

The principles of this investment strategy can be applied to stocks, specific industries, and entire markets.

Contrarians see an opportunity because they believe that the value of a stock is less than its intrinsic value. The pessimism of other investors pushes the price below what it should be, and contrarians buy it before the prices rebound. 

If you want to be a contrarian investor, it is recommended to pay attention to distressed stocks and sell them once the price has recovered well.

As with other strategies, there are risks involved with contrarian investments because they can pave the way for high losses without proper research and timing.

10. Diversification

Diversification is the practice of spreading your investments across different asset classes, industries, and regions to minimize risk and maximize returns. The main philosophy of this strategy is to “not put all your eggs in one basket.”

This strategy can be achieved through various means such as investing in stocks, bond funds, real estate, and alternative assets like cryptocurrency.

By diversifying your portfolio, you can reduce the impact of market volatility and protect your investments from a single industry or stock underperforming. This helps investors to stay invested during market downturns since they have a well-balanced portfolio.

When it comes to diversification, there is no one-size-fits-all approach. The key is to have a well-rounded portfolio that aligns with your investment goals and risk tolerance.

For instance, a young investor with a higher risk tolerance may opt for a portfolio that is heavier on stocks and alternative assets, while someone approaching retirement may choose a more conservative portfolio that includes more fixed-income investments.

Despite its advantages, diversification also comes with some potential downsides. One of the main disadvantages is that it can limit potential returns.

By investing in a wide range of assets, investors may miss out on the high returns of a single asset that performs exceptionally well.

Additionally, diversification can be challenging for individual investors since it requires a deep understanding of various asset classes and industries.

Diversification may not be able to protect against systematic market risks, such as a global financial crisis.

11. Dollar-cost Averaging

If you’re new to investing or you’re unsure about timing the market, dollar cost averaging can be a great strategy to start with.

This investment strategy involves investing a fixed amount of money at regular intervals over a period of time, regardless of market conditions.

This approach aims to smooth out the impact of market volatility by spreading out the investment across different market cycles.

For example, instead of investing a lump sum of Php100,000 in a stock all at once, you’ll invest Php10,000 every month for 10 months. This will help you avoid the risk of investing a large amount of money during a market peak and potentially losing a significant portion of the investment if the market

This strategy is particularly useful for investors who are risk-averse and those who are investing for a long-term goal, such as retirement.

By investing a fixed amount regularly over a longer period of time, investors can benefit from the power of compounding and potentially see higher returns on their investments.

One potential downside of dollar-cost averaging is that it can limit potential gains if the market consistently performs well.

The investor may miss out on the opportunity to buy at a lower price and benefit from higher gains when the market eventually rises.

Additionally, it can be difficult to consistently invest a fixed amount if financial circumstances change.

Overall, dollar cost averaging is a simple and effective strategy for new investors who want to start investing without the pressure of timing the market.

Growth vs. Value Investing

Value investing involves choosing stocks that look as if they trade for less compared to their intrinsic value. Basically, these stocks are being underestimated by the market.

With growth investing, an investor chooses to invest capital in junior companies’ stocks which can potentially grow in earnings.

Wall Street categorizes stocks as either value or growth stocks. However, things are a bit more complicated in reality since there are stocks that have elements of both growth and value.

Nevertheless, value and growth stocks have important differences.

Value stocks

These are shares of a fundamentally solid publicly traded company that are priced lower compared to its peers.

Value stocks are relatively cheap if you consider their long-term growth potential as well as their earnings. Their growth characteristics are not flashy.

Rather, these companies have steady and predictable business models which generate modest revenue gains and earnings over time. Value stocks can sometimes be found in companies that are in decline.

They have a really low stock price, which often causes their future profit potential to be undervalued.

Growth stocks

Growth companies start out as up-and-coming businesses, and their priority is to become leaders in the industry that they are in as quickly as possible.

Early on, they tend to focus on building their revenue up, often delaying profitability. After some time, they begin to work on maximizing profits more.

Growth stocks often come with relatively high valuations when they are measured by price-to-book value or price-to-earnings ratios, but they also have faster growth in income and revenue than their peers.

Which is Better?

Go for value stocks if you want your portfolio to have current income, want more stability in stock prices, are confident in your ability to avoid value traps, and if you want your investment to have a more immediate payoff.

Choose growth stocks if it is not an issue with you that your portfolio is not currently earning, if you are fine with big movements in stock prices, if you are confident in your ability to pick winners out in industries that are emerging, and if you have plenty of time before needing your money back.

In terms of long-term performance, growth stocks often relatively outperform value stocks when the economy is good, while value stocks usually hold up better during difficult economic times.

Passive vs. Active Investing

Passive and active investing are two distinct approaches to portfolio management, each with its own strategies, goals, and levels of involvement.

Here’s a breakdown of the two:

Passive Investing is generally preferred by those who want a “set it and forget it” approach, are looking for lower fees, and are content with market-average returns.

Active Investing appeals to those who believe they can beat the market through skillful selection and timing, are willing to pay higher fees for potentially higher returns, and are comfortable with the additional risk that comes with active management.

The choice between passive and active investing depends on an individual’s investment philosophy, risk tolerance, time horizon, and the level of involvement they wish to have in managing their investments.