How To Invest Your Money: Part Three – Finding Your Strategy

This is part three of a four part series on how to invest your money.  The main focus of this series of articles is to discuss the psychology of investing, how to get started, finding your strategy, and building your portfolio.  I hope this can be a resource for many people who are looking for information on how to invest their money.

Finding Your Strategy

Now that you have identified your investment goals it’s time to determine how to invest your money.  There are many different investing strategies to choose from.  Experts in each discipline will claim to have the best method for you to invest your money, but ultimately you need to find the right strategy for your situation.

The two most common methods of investing would be a passive investing approach and an active investing approach.

Passive Investing

Passive investing is a strategy involving very limited ongoing purchasing and selling actions.  Passive investors purchase an indexed ETF or mutual fund and hold it for the long term based on a pre-determined asset allocation.  When the asset allocation becomes out of balance due to over/under performance of certain sectors or when new money is added, the portfolio should be re-balanced.

Unlike active investors, passive investors buy a security and typically don’t actively attempt to profit from short-term price fluctuations.  Passive investors instead rely on their belief that in the long term the investment will be profitable.

One of the most common passive indexing strategies is the Global Couch Potato.  This portfolio includes a Canadian Equity index fund, a U.S. and International equity index, and a Canadian Bond index.  The benefits of a portfolio like the Global Couch Potato is the diversification and relatively lower risk (with the fixed income component), as well as the minimal fees required to maintain the portfolio.

A common misconception is that you can’t be a passive investor if you hold individual stocks.  This is simply not true, as the famous buy-and-hold investor Warren Buffet said, “Our favorite holding period is forever”.

The idea behind dividend growth investing is to purchase worthwhile amounts of blue chip stocks that have a history of raising their dividends and holding them for the growing income.

This method takes patience and discipline to hold the dividend stocks for decades through the ups and downs of the market, but does not require any more active management than an index investor re-balancing their portfolio.

Active Investing

An active investment strategy involves ongoing buying and selling actions by the investor.  Active investing is highly involved.

Unlike passive investors, who invest in a stock when they believe in its potential for long-term appreciation, active investors will typically look at the price movements of their stocks many times a day.  Typically, active investors are seeking short-term profits.  Some active investing methods would include:

  • Swing Trading – A style of trading that attempts to capture gains in a stock within one to four days.  Swing traders look for stocks with short-term price momentum.  These traders aren’t interested in the fundamental or intrinsic value of stocks, but rather in their price trends and patterns.
  • Momentum Investing – Also known as “Fair Weather Investing”, is a system of buying stocks or other securities that have had high returns over the past three to twelve months, and selling those that have had poor returns over the same period.
  • Dogs of the Dow/TSX – A method where an investor buys the 10 highest yielding stocks in the Dow Jones Industrial Average or the TSX 60 and holds them for a period of one year, at which time the investor would sell the portfolio and purchase the new “dogs”.

What’s Right For You?

In order to figure out how to invest your money you need to understand what type of investor you want to be.  You can choose to be an active investor who takes on greater risks in trying to beat the market, but enjoys analyzing stocks and the excitement of short term buying and selling.

Or you can choose to be a passive investor who wants to limit risk, accept what the overall market returns, pay less fees, and trust in the long term benefits of staying invested in the market.

In the final part of this four part series on how to invest your money I will talk about building your investment portfolio in order to achieve your financial goals.

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  1. Canadian Couch Potato on February 2, 2011 at 12:34 pm

    “A common misconception is that you can’t be a passive investor if you hold individual stocks.” This is not a misconception, it’s true. In all discussions of active v. passive investing in the academic literature and among practitioners, “passive” specifically means making no attempt to select individual securities. It means using index funds and making no attempt to time their purchases. This isn’t my opinion, it’s the way everyone in finance defines the term.

    A dividend growth strategy is an active strategy, no matter how long the holding period. It’s buy-and-hold, but it’s not passive. That’s not a value judgment either way, but the distinction is important.

    • Echo on February 2, 2011 at 12:54 pm

      Hi Dan, nice to chat with you over here for a change 🙂

      Thanks for the clarification. I always assumed that passive meant trying to limit the number of opportunities to buy and sell, while active meant to deliberately buy and sell in order to profit in the short term.

      Definitions aside, I still believe that I spend no more time with my portfolio than an index investor does when they re-balance. I don’t buy into the “2 minute” portfolio.

      And in either case (active vs. passive) you can’t ignore that adding new money automatically “times their purchase” in the accumulation phase. So does the initial “buy” for that matter.

  2. BeatingTheIndex on February 2, 2011 at 4:05 pm

    In my opinion, passive investing is the way to go for anyone who does not have the time to put into research, education and following the market. Moreover, active investing requires a good dose of interest on the investor’s part.

  3. Canadian Real Estate Investment Trust on February 3, 2011 at 8:01 pm

    I wonder where that leaves me?

    I advocate buying dividend paying securities and reinvesting the dividends. Waiting for capital gains is just plain crazy, in my opinion – not to be shy about it.

    But I also believe in diversifying to reduce risk. Therefore, I do advocate buying Exchange Traded Funds that cover the various kinds of income producing securities. US and international stocks, US and international REITs, etc.

    The only exception is Master Limited Partnerships. For technical reasons there is currently no way to buy them directly through an ETF. So as I can, I’m buying the ones included in one of the major MLP indexes, so my account will be its own “index fund.”

    And I don’t believe in selling, unless the income stream stops or it really looks as though a company is about to go out of business. Of course, if you own only indexes, that’s taken care of for you.

    • Echo on February 3, 2011 at 10:30 pm

      It sounds like you have a mix of both passive and active approaches, which is just fine. You need to find an approach that works for you and your unique situation. I’m not a fan of any cookie cutter approach.

      Thanks for your comment!

  4. Doable Finance on March 31, 2011 at 8:05 am

    Thanks Echo for an enlightening article.

  5. Witty Artist on September 2, 2011 at 2:21 am

    I think that for the beginning a passive investing would be the choice for anyone who want to start investing. It doesn’t require so much previous knowledge and time to follow the market. When someone has some financial knowledge as well as the patience (better said, nerves) to daily monitor the market, then they could go into active investment.

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