What is an Investment Strategy?
How to understand and evaluate investment strategies
Each investor spends a significant amount of research and time considering a client’s future capital needs, comfort with risk and individual goals in order to form a plan of attack that guides investment choices. This is known as an investment strategy. An investment strategy typically includes guidelines for asset allocation, assessing risk and determining when to buy and sell.
“Investment strategies can differ greatly from a rapid growth strategy where an investor focuses on capital appreciation to a safety strategy where the focus is on wealth protection,” according to Investopedia. “The most important part of an investment strategy is that it aligns with the individual's goals and is closely followed by the investor.”
If you’re looking to form an investment strategy for making your own investments, Investopedia has put together the following four questions that you should answer:
Can you write down your strategy?
Writing down your strategy ensures that it is complete and that you fully understand what your goals are and the framework that you will follow to achieve them.
“Writing down your strategy gives you something to revert back to in times of chaos, which will help you avoid making emotional investment decisions,” according to David Allison from Investopedia. “It also gives you something to review and change if you notice flaws, or your investment objectives change.”
Does your strategy include a way to determine if an investment is over or undervalued by other investors?
Examine ways that you can determine if an investment seems to be over or undervalued by other investors. This may be special industry knowledge, or any other competitive advantage that sets you apart as an investor. Once you figure out your advantages, use them to choose investments that others may miss.
How will your strategy perform as the market changes, and when will it do poorly?
Looking ahead to determine when you think your investment strategy will do poorly can help you form action plans for those times. It can also prevent you from acting rashly and making bad decisions.
“As market trends and economic themes change, many great investment strategies will have periods of great performance followed by periods of lagging performance,” states David Allison. “Having a good understanding of your strategy's weaknesses is crucial to maintaining your confidence and investing with conviction, even if your strategy is temporarily out of vogue.”
How will you measure the effectiveness of your strategy?
If you don’t have parameters in place for measuring the success of your strategy, you won’t be able to figure out when to make changes or determine what those changes should be.
Even if you aren’t forming your own strategy, it’s important to understand the strategy a fund manager uses. This will help you choose the best fund manager to meet your personal goals.
“The criteria that mutual fund managers use to select their assets vary widely according to the individual manager,” states Dan Weil from Bankrate. “So when choosing a fund, you should look closely at the manager's investment style to make sure it fits your risk-reward profile.”
Top-down and bottom-up investing strategies are two of the most popular. Top-down involves picking assets that fit into an overarching theme of the market. An example would be buying stocks across the board based on the hypothesis that the market will improve greatly in the near future.
This strategy has the benefit of providing a big payout when the overall theme is correct because all investments were chosen to match that theme. On the other hand, there is no guarantee that the investor was right about the theme, and even if the theme was correct, the investor might have chosen the wrong investments to support it.
Instead of looking at the overall market and fitting investments into the general picture, bottom-up investors choose investments based on their individual performances and strengths. These investments are considered good or bad, regardless of the overall market.
“A bottom-up manager benefits from thorough research on an individual company, but a market plunge often pulls even the strongest investments down,” states Weil.
There are countless investment strategies, so be sure to talk to your financial institution about any questions you have. It’s the best resource for finding your perfect investment strategy. Please don’t hesitate to give us a call with any questions.