What is the best investment strategy?
Defining a good investment strategy is critical when you are going to invest. Not every investment strategy suits every type of investor. In this article we will discuss the best investment strategies so that you can decide which way of investing suits you best.
What is the best investment strategy?
Unfortunately, there is no holy grail of investment: there are different investment strategies, each with its advantages. It is therefore advisable to try out different strategies: in this way, you will automatically discover which strategy gives you the highest return. In this article we will discuss the most popular strategies in detail so that you know the available possibilities.
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What are the most popular investment strategies
- Value investing: look for stocks that are undervalued.
- Growth investing: look for shares that can still grow substantially.
- Dollar-cost averaging: enter the stock market in a staggered manner.
- Investing momentum: invest in the direction of the trend.
- Speculate: trade actively in stocks in the short term.
- Invest for dividend: build up a fixed income with shares.
- Social investment: investing in green & ethical companies.
- Small-cap investing: investing in small businesses.
- Contrarian investing: buy stocks when the price falls.
- No strategy: investing like a sheep is not a good idea.
Value investing is the same strategy Warren Buffett applies. Warren Buffett has proven that you can achieve a good return with this strategy: year after year he managed to beat the S&P 500 with an average annual return of 20%.
The principle behind value investing is to buy shares that are undervalued. Investors using this strategy believe that stock prices do not directly reflect a company’s intrinsic value. This belief is not unrealistic: the market is determined by supply and demand and people do not always react rationally. People sometimes buy shares which are seen as hype and ignore interesting but boring companies.
This investment strategy only works well if you have a lot of patience. The strategy is therefore really focused on the long term: you buy stocks or an index fund, and you hold on to it for a longer period of time. Many investors achieve mediocre results with this strategy because they panic and sell their shares. This is a shame; if you conduct your research, you can achieve a high return with value investing.
Do your homework
When you invest in value shares, it is crucial to do your homework well. As a value investor, you actually have to eliminate all noise to focus on the big picture. The decisions you make should be based on trends that focus on decades into the future. Consider whether a particular industry or sector still has opportunities for growth in the future and study the company’s financial data. Is the company currently undervalued? In that case, it may be interesting to buy the stock.
Investors who invest by looking at the net asset value of a stock often use the price/earnings ratio or P/E. This ratio indicates how many times the profit the stock is traded. You can then compare this ratio with the ratios of other shares in the same sectors to determine whether the share is undervalued.
According to research, this method of investing almost always yields higher returns in the long term. Only during the Great Depression of 1929, the dot com bubble in 1999 and the period from 2004 to 2014, this method of investing was not the most profitable. Fortunately, investment strategies are flexible: you can always choose to switch to another investing strategy.
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Another popular investment strategy is growth investing. Investors using this investment strategy are often looking for the next great invention. If you want to be successful with growth investing, you have to select stocks that are not performing well yet but do have a lot of potential. This can be a stock that gets a lot of attention recently.
If you had bought Apple shares at the launch you would have become very rich by now. A more recent example is the enormous advance of Tesla and Uber: these stocks are also clear examples of growth stocks, as they are traded against highly elevated prices relatively to their profitability.
Is growth investing the same as speculating?
Growth investing is not the same as speculation: the focus in growth investing is still on the longer term. When applying this strategy, it is important to also examine the health of the underlying company and the growth potential. Within the strategy you buy shares in order to hold on to them for a longer period of time. Nevertheless, as a growth investor, it is important to be more flexible: these companies are often not very stable, so it can be important to sell your stocks in between.
Investing in growth stocks has one major disadvantage: you often do not build up an income with them. Since companies make little or no profit in the growth phase, they usually do not pay out a dividend. The focus is therefore entirely on the growth of the company and the expectation for further future growth. Rumours therefore have a stronger influence on the price of growth stocks.
Is growth investing profitable?
Over a longer period of time, value investing seems to be more profitable: however, this does not mean that growth investing is less profitable. In specific periods of time, growth investing can be profitable.
It is when you want to apply this strategy that it is particularly important to stay focused. Growth stocks often fall in value faster when the economy is not performing well. Moreover, it is important to ask yourself whether the company is sufficiently innovative. For example, the GoPro stock price fell sharply after it had become worth almost three times as much: the product was certainly valuable, but turned out to be easy to replicate.
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I am a big fan of an investment fund where dollar-cost averaging plays an important role. Dollar-cost averaging is actually not a stand-alone investment strategy: you can use this strategy in combination with the other strategies in this article.
The principle behind dollar-cost averaging is that it is very difficult to predict the market. You often do not know whether the market is at a high or low point. Even when a new record price has been set, the rate can still rise for years to come. At the same time, the financial markets could collapse tomorrow. Dollar-Cost Averaging offers a solution to this uncertainty.
Spread your investments
When you apply this strategy, you no longer have to worry about timing. For many investors it is tempting to try timing the market. However, in many cases it is smarter to step in staggered, and this is what you do with a DCA strategy.
You then decide, for example, to invest a certain amount each month. You can then choose to invest this amount monthly in an investment fund, or you can also purchase a set of shares each month. By applying this strategy, you avoid investing a large amount of money at the wrong time. It is advisable to carefully review your financial situation in advance so that you have a clear overview of the amounts you can invest periodically.
Does dollar-cost averaging work better?
Research shows that dollar-cost averaging does not necessarily work better. If you really know how to time investments well, you can often make more profits. You would then have to buy more stocks when the market is underperforming and sell shares when the market is doing very well.
The problem is that our emotions often get in the way: especially for novice investors, it can sometimes be difficult to ignore your prejudices. Moreover, by applying the dollar-cost averaging strategy you avoid a lot of stress: you will never again feel that your investments have been mistimed, since you are following a system that you have set up yourself.
Further risk diversification
If you want to limit the risks of your investments as much as possible, you have to make sure that your investments are sufficiently spread. By applying dollar-cost averaging, you already make sure that you get in at different times and that the risk decreases over time.
You can limit your risks even more by spreading your investments across different regions and sectors. In this way you can absorb losses in one region or sector through successes in the other. Keep in mind, however, that spreading the risk also reduces the chance of huge profits.
Momentum investing follows the motto: the trend is your best friend. When you apply the momentum investing strategy, you buy shares when they are in a rising trend. If the price falls, they often look for shorting opportunities. When you open a short position, you get a positive result when the stock price drops. To successfully benefit from momentum investing, fairly active trading is required.
This is immediately a major disadvantage of the momentum investing strategy: if you often have to buy & sell stocks, you pay transaction costs over and over again. According to this scientific paper, momentum investing works especially well when buying & selling is done on a monthly basis. With this way of investing you really need to find a good balance and not want to open positions too often. With momentum investing it is of course extra important to choose a broker with low transaction fees.
Taking short positions can be an important part of a momentum investment strategy. However, this is not without risk: in theory, your risk is unlimited. A share can never fall further than 0, while the price of a share can double in value many times. If you apply short selling irresponsibly, your loss can increase rapidly.
With momentum investing, if you have sufficient experience and practice a lot, you can achieve better results. However, it is important to take the risk of short positions into account. Momentum investing is therefore only suitable for the somewhat experienced investor.
If you also like investing as an activity, you can choose to actively speculate on the market. Active speculation can be very profitable, but the emphasis is on can.
Investors who speculate open positions in the very short term. You then try to take advantage of market volatility caused by rumours or a news report. When a company publishes its annual figures, you can open a position on them. If the figures are better than expected, you can see that the stock price rises and if the figures are disappointing, the share price falls.
If, as an active trader, you manage your risks well, then even if you make the right decision in less than half of the cases, you can achieve a positive result. This method of investing requires nerves of steel and sufficient time and knowledge. Would you like to learn more about speculation? Then read our extensive manual on speculating on the stock market:
Most of the investment strategies we have discussed place the emphasis on achieving price gains. You select stocks that you expect to rise in the future and buy them. Not all investors are looking for price gains: there are also many investors who invest to build up an income.
If you want to build up an income with shares, you have to look for shares that pay out a high dividend. High dividend paying stocks are often shares of the more stable companies with limited growth. There are also special ETFs that focus on high-dividend stocks.
Even if you invest fully to create an income, it is still advisable to keep an eye on the stock price development. A dividend of five per cent is of little use if the stock price falls by ten per cent every year. Therefore, check whether the company’s stock price is reasonably stable. By buying in periodically, you also prevent investing all your money just at the top.
Do you have certain ideals and do you think it is important that they are included in your investment strategy? In that case, you can actively look for socially responsible investments. Socially responsible companies take into account the influence their business operations have on other stakeholders.
It is important to think for yourself what you see as socially responsible. The concept of social responsibility is very subjective and not everyone has the same idea about it. Incidentally, socially responsible investment can be a good strategy, as conscious investing is becoming increasingly popular. If more people only invest in stocks that are good for the environment, this can give a boost to this type of company.
Another investment strategy is to invest in small companies. Small-cap companies include companies with a market capitalization of between USD 300 million and USD 2 billion. These shares can be particularly attractive, as they are often less conspicuous. As a result, shares in smaller companies can sometimes be significantly undervalued. Moreover, there is a chance that they will be bought by a competitor for a nice premium.
Investors who do not mind taking greater risks can also choose to invest in penny stocks. Penny stocks are stocks that are literally worth a few cents. An advantage of investing in this type of stock is that you can quickly achieve a substantial return: when the price rises from one cent to two cents you immediately achieve a return of 100%. However, you also have to be careful with this type of company, because the chance of them going bankrupt and losing your entire investment is also much greater.
Investors who apply the contrarian investment strategy correctly can achieve a high return. A disadvantage of this investment method is that you can only apply this strategy when the economy is underperforming and share prices are falling. When you use the contrarian investment strategy, you buy up stocks in strong companies that (hopefully temporarily) fall in value.
This strategy works well because many people panic when stock markets crash. Although companies may be adversely affected by the crisis, the effects on strong companies are often temporary. In some cases, a crisis can even benefit a strong company: for example, when other companies fall, competition is reduced.
When applying this strategy, it is important to pay extra attention to selecting the right shares. The company has to be profitable when the economy is performing well: when this is not the case, your strategy will not work out, and you lose money in the long run.
The majority of new & novice investors do not have a strategy at all. We also call this group the herd of sheep. These are often the investors who buy an enormous number of stocks just before the share price collapses. They realize something positive is happening too late and lose money because they buy the stocks when everyone is already taking their profits.
If there is one lesson I want to teach you in this article, it is that you should not be a sheep. Every investor needs a strategy. Fortunately, an investment strategy does not have to be complicated at all! In the rest of the article we will briefly discuss how you can put together a good strategy yourself.
Composing an investment strategy
Now that you know what investment strategies exist, you can compose your strategy. A strategy should always suit your personal situation. For example, if you have little time, you should not opt for active speculation. Therefore, first choose a clear strategic direction and then adapt the preconditions of the strategy to your personal preferences.
A good first step in composing your investment strategy is to write down your goal. Determine how much you want to earn with your investment and determine how long you have to achieve this amount. Based on your goal you can determine whether a short or long-term strategy suit you better.
Determine the initial amount you start investing with and calculate how much extra money you can invest periodically. By clearly stating your financial situation on paper, you avoid getting into trouble because you are investing money you can’t really afford to lose.
Draw up clear rules for your strategy. When do you buy a share, and when do you sell a stock? Clear rules are important and prevent you from making emotional decisions that are unlikely to benefit your profitability.
It is important to regularly evaluate both your investments and your strategy. A good investor is a flexible investor: by always remaining critical of your own skills, you avoid losing a lot of money unnecessarily with your investments.
In theory, any investment strategy can work: in practice, some strategies are better suited to you than others.
Short versus long term
You have now seen a clear overview of the different investment strategies. You can also divide the strategies into short and long-term strategies.
Short-term investment strategy
In the short term, you will have to adopt a different investment strategy than in the long term. In the very short term, you are more likely to speculate: you then try to predict the price in the short term. You can then take advantage of a small price movement by opening an investment position and closing it again a few days later.
You can invest in the short term by using a CFD investment strategy. CFDs are contracts on securities that make it possible to profit from price fluctuations in the (very) short term. When determining a short-term strategy, the following is important in any case:
- When do you get in and why? Make a clear analysis.
- Use a stop loss to avoid losing too much on one position.
- Use orders to automate purchases.
In the short term, the focus of an investment strategy is much different; you are usually looking for a quick profit. The fundamental aspects or the underlying figures are then much less important. In this form of investment, the emphasis is often on the things that stand out in the short term; think, for example, of speculation based on the news or the analysis of patterns on a chart.
Do you want to learn how to trade in the short term? Read our investment tutorial for more information:
Long-term investment strategy
When you plan to buy physical shares, a long-term strategy is more appropriate. Think of Warren Buffett‘s investment strategy; buying undervalued stocks and then holding on to them for a longer period of time. Only once the shares have increased in value enough you consider selling them again.
Even if you invest in the long term, there are all kinds of strategies to devise. Think, for example, of the way in which you select shares or the way in which you divide your money between shares and less risky bonds.
How do you determine the best investment strategy?
The best investment strategy often depends on your personality. People who like to avoid risk might be better off investing in the long term physically. If you don’t mind high risks, you can invest in more risky investment products such as CFDs.
Determine for yourself how much risk you want to take with your strategy. After all, there is no one-sided strategy; a strategy is ultimately entirely personal. To find a suitable strategy, it is important to have a clear picture of your own risk profile.
Composing your strategy
When you know how much risk you want to take, you can put together your own strategy. You can do this by setting disciplined rules. Think for yourself when you buy or sell certain stocks and then stick to those rules.
It is important to practice and experiment a lot. In this way you can perfect your strategy before you start investing with real money. With a demo account, you can experiment and discover which strategy suits you best. That is why you should first open a demo account with a broker!