Whether you are a do-it-yourself investor or you rely on a financial advisor you have an overall strategy of choosing your investments based on your profile, risk tolerance and beliefs that will enable you to achieve your objectives.
Related: 5 Challenges DIY Investors Face
What investing style fits you?
An index is a broad representation of a market and is considered the benchmark for performance. The theory behind index investing – also called passive investing or couch potato investing – is that it is almost impossible to consistently outperform market averages. Index mutual funds and basic ETFs replicate and passively follow the ups and downs of market indexes such as the S&P/TSX Composite Index or the DEX Universe Bond Index. They aim to match the returns of the benchmark as closely as possible.
This is a good starting point for beginning investors and is also successful over the long term for anyone who doesn’t have the time to follow and research the markets and/or wants good performance at low cost.
Finance writers such as David Chilton and Suze Orman were advocating index investing way back in the 1980’s. Those who chose this strategy at that time, stayed the course through market fluctuations, and re-balanced as required, would likely be sitting pretty today.
The classic allocation is 40% Bonds / 20% Canadian equities / 20% US equities / 20% International equities, but you can choose any balance that suits your risk tolerance and time horizon.
The appeal of buying dividend-paying stocks is, of course, the predictability of income. If you own shares in solid companies you are virtually certain of receiving the quarterly (or sometimes monthly) payment, regardless of market fluctuations.
A great investment is a company that is value priced, has growing revenue and increasing dividends, that is held for the long term – also known as buy-and-hold investing.
Some companies offer stock purchase and dividend reinvestment plans for little or no cost, making it affordable for small investors.
The main disadvantage can be lack of diversity, for small portfolios and investors who hold only Canadian dividend payers. To offset this, you can purchase US companies (see US Dividend Aristocrats), especially those conglomerates that have global holdings and/or Deposit Receipts.
Value investors are avid sales shoppers. If you are willing to put in the effort look for out of favor stocks whose intrinsic value is higher than the market price, have low price to earnings ratios and generally have higher dividend yields.
One value strategy is known as “Dogs of the Dow.” With this strategy the top ten stocks are chosen at the end of the year that have the highest dividend yield relative to price. Invest an equal dollar amount in each stock, and then repeat the following year.
David Stanley has a similar approach for Canadians called “Beating the TSX.”
This is an active management style for sophisticated investors or people who like to pay money managers the big bucks for results. It involves the analysis of companies, financial markets and economic trends.
Analysts carefully select holdings from companies that have potentially high earnings, growth rates, and high profit margins. These companies are often innovators in their fields (think Research in Motion when they first introduced the Blackberry) grow quickly and reinvest most or all of their earnings in continued growth for the future.
To be successful you need to buy early and have a definite sell price. By the time the average investor hears about these companies on the local newscast, it’s likely too late.
All of these styles have their fans, and no one style is inherently better than another. Clearly defining the investment style that fits you will help you select investments that you will feel comfortable holding.
Some investors have a main strategy and include a portion of their holdings in another, such as an index investor who also holds some individual stocks.
Related: How To Manage Your Investment Risk
Sometimes your style may change – especially when knowledge, risk, time horizon and time available to spend on the portfolio changes.
In my case, I used to hold a fairly aggressive portfolio of actively managed mutual funds. Then I switched my focus to dividend payers. Now I’m considering taking some of my profits and adding a few ETFs.
What is your investing style?