What's an investment strategy?
An investment strategy is a way of thinking that shapes how you select the investments within your portfolio. The best investment strategies should help you meet your financial goals and grow your wealth while maintaining a level of risk that lets you sleep at night. The investment strategy you choose may influence everything from what types of assets you have to how you approach buying and selling those assets.
If you're ready to start investing, a good rule of thumb is to start by asking yourself some basic questions: What are your goals? How much time until you retire? How comfortable are you with risk? Do you know how much you want to invest in stocks, bonds or an alternative?
This is where investment strategies come into play.
The best investment strategies increase the money investors make and decrease their exposure to risk.
The strategy will vary depending on your end investment goal and its timeframe, how much tolerance for risk you have and how involved you want to be in choosing individual investments.
Many investors combine multiple strategies to find the best personalized strategy to fit their situation.
Beginner investment strategies
If you’re not yet investing, there are some simple steps you can take to begin. If you have a 401(k) through your employer, make sure you’re enrolled and investing at least enough of your salary to receive any company match; then choose investments that are aligned with your goals. You should know that most 401(k)s offer relatively few investment choices, so the options for strategy within those vehicles are usually limited.
Another way to invest for retirement is to open an IRA through a brokerage account, which will give you access to a more expansive world of investments than your 401(k) may offer. You can also trade through a brokerage account for long-term goals other than retirement.
» Need more direction? Read How to Invest at Any Life Stage
Popular investment strategies
There are numerous ways to approach investing, but here are some of the more popular investing strategies to consider.
It’s always nice when things have a clear label, and you can’t get much clearer than “buy and hold.” Buy-and-hold strategists seek investments they believe will perform well over many years. The idea is to not get rattled when the market dips or drops in the short term, but to hold onto your investments and stay the course. Buy-and-hold works only if investors believe in their investment’s long-term potential through those short-term declines.
This strategy requires investors to carefully evaluate their investments — whether they are broad index funds or a rising young stock — for their long-term growth prospects upfront. But once this initial work is done, holding investments saves time you would have spent trading, and often beats the returns of more-active trading strategies.
» Want to know more? Dive into details on buy-and-hold investment strategy
Active investors prefer trading more frequently and opportunistically to capitalize on market fluctuations. Stock traders may use technical analysis, the study of past market data such as trading volume or price trends, to help anticipate where market prices might go.
Active trading includes different strategies based upon pricing, such as swing or spread trading, and can also include momentum and event-driven strategies. Momentum investing seeks to identify and follow trends currently in favor to profit off of market sentiment. Event-driven investing strategies attempt to capture pricing differences during corporate changes and events, such as during mergers and acquisitions, or a distressed company filing for bankruptcy.
» To time or not to time? Learn more about market timing
The biggest challenge to timing the markets is getting it right on a consistent basis. For those investors wary of trying their luck on market timing but still wanting a good entry point into the market, the strategy of dollar-cost averaging may appeal.
Investors who dollar-cost average their way into the market spread their stock or fund purchases out over time, buying the same amount at regular intervals. Doing so helps to "smooth" out the purchase price over time as you purchase more shares when the stock price is down and buy less shares when the stock price is up. Over time, you gain a better average entry price and reduce the impact of market volatility on your portfolio.
While there are active and passive approaches to investing, there are also active and passive investments themselves when deciding between various types of funds. Investors frequently use mutual funds, index funds and exchange-traded funds (ETFs) to populate their investment portfolio because funds provide access to a collection of securities, generally stocks and bonds, through one vehicle. Funds allow investors to benefit from diversification, spreading investment risk across many securities to help balance volatility.
Active funds employ a portfolio or fund manager to handpick certain investments to populate the fund based upon proprietary research, analysis and forecasts. The manager's goal is to outperform the fund's corresponding index or benchmark. Passive funds, such as index funds and most ETFs, simply mimic an underlying index, providing the investor with similar performance to that particular index.
Some mutual funds have high expense ratios or high minimum investments (or both). But investors can often sidestep the highest of such costs by comparison shopping among mutual funds, or by favoring index funds and ETFs, which tend to offer lower expense ratios than actively managed funds. Given the lower cost of passive funds and the arduous task of beating the benchmark facing portfolio managers, index or passive investing often delivers better overall returns over time.
Growth investing involves buying shares of emerging companies that appear poised to grow at an above-average pace in the future. Companies like this often offer a unique product or service that competitors can't easily duplicate. While growth stocks are far from a sure thing, their allure is that they might grow in value much faster than established stocks if the underlying business takes off. Growth investors are willing to pay a premium price for these stocks in exchange for their robust future growth potential.
New technologies often fall into this category. For example, if someone believes that home buyers are going to shift increasingly from banks to online mortgage lenders with a streamlined application process, they might invest in the lender they believe will become dominant in that market.
Investors can also look toward burgeoning geographies or companies to find growth. As they industrialize, emerging markets or developing economies usually are more volatile but also grow at a faster pace compared to their more-developed peers. Companies are valued by market capitalization, or market cap, which is calculated by their total outstanding shares available times the market price of the shares. Small-cap stocks, shares of companies usually valued at $2 billion in market cap or less, provide investors with greater potential risk but also greater potential return due to their faster growth trajectory.
» Research investments: Read our review of Morningstar
Made famous by investors like Warren Buffett, value investing is the bargain shopping of investment strategies. By purchasing what they believe to be undervalued stocks with strong long-term prospects, value investors aim to reap the rewards when the companies achieve their true potential in the years ahead. Value investing usually requires a pretty active hand, someone who is willing to watch the market and news for clues on which stocks are undervalued at any given time.
Think about it like this: A value investor might scoop up shares of a historically successful car company when its stock price drops following the release of an awful new model, so long as the investor feels the new model was a fluke and that the company will bounce back over time.
» Grow your investment. Compare and contrast growth and value investing
Value investing is considered a contrarian strategy because investors are going against the grain or investing in stocks or sectors currently out of favor. A subset of investors take value investing a step further by not just investing in cheaper stocks and sectors but purposely seeking out the cheapest ones out there to invest in so-called deep value.
Investment strategies can help investors achieve a particular aim; for instance, producing a steady income stream. Many investors use income investing to help cover their living expenses particularly when transitioning into retirement.
» Looking for regular income? Learn what bonds may bring to your portfolio
Socially responsible investing
Social issues such as climate change and racial justice impact lives on a day-to-day basis. Socially responsible investing (SRI) aims to create positive change in society while also generating positive returns. In addition to investment performance, SRI investors look into a company’s business practices and revenue sources to ensure they're aligned with their personal values.
Some investors employ SRI by excluding stocks of companies that go against their moral compass; for instance, they might exclude investments in “sin” stocks or tobacco- and alcohol-related companies. Others intentionally direct their investment dollars toward issues they care about, such as into renewable energy companies.
» Want an ethical portfolio? Learn more about socially responsible investing
Principles of investment strategies
Whatever investment strategy you choose, it’s important to consider your investing goals. Where your investment style will fall in the following categories depends on many factors: Everything from your age to your finances and even your comfort level doing it yourself will help determine what your portfolio will look like.
Long-term goals vs. short-term goals
When investing for long-term goals — those five years or more in the future — it may make sense to choose higher-yielding (but more volatile) instruments like stocks and stock funds. But there are smart ways to pursue short-term savings goals, too. If you’re saving for a down payment on a house, you may want to place those savings in a more stable environment, like CDs or a high-yield savings account. Since you have a shorter time frame for your money to grow with a goal like this, there is less time to weather the volatility of the stock market.
» Saving for the short term? Read about the best short-term investment accounts
Long-term savings goals, such as retirement, can handle the fluctuations of the market. Since those investments will be in the market for longer — provided the investor can stay the course when there are major changes in the short term — there is less need to worry about those shorter-term dips. These long-term investments are better served by a mix of stocks and bonds or stock mutual funds.
Low-risk vs. high-risk investing strategy
Investment strategies always come with some amount of risk, and in almost every way risk and reward are linked. Investors who pursue higher rewards are usually taking bigger risks. For example, a bank CD is insured by the Federal Deposit Insurance Corp. and has virtually no risk. It also pays very little in return. A young tech startup’s stock, on the other hand, is likely higher-risk, but there is a chance it could explode in value.
There are many shades of risk in between, but whatever path you choose, make sure you’re prepared to deal with them.
Do-it-yourself vs. hiring professional help
Investors have many choices when it comes to managing their investment portfolio. How involved do you want to be in the investing process? How much do you already know about investing? Beginner investors may prefer to hand their savings off to a robo-advisor — an automated, low-cost investing service — rather than take on the challenge of making all the choices themselves.
More advanced investors or avid DIYers might opt to take a more active role, whether that means trading every day or just keeping tabs on their portfolios. Active investing can be a lot of work and may not give you higher returns than passive investing strategies.