Investment Strategies - Basic Investment Strategies

Market Timing
In a market timing approach, the portfolio manager seeks maximum capital gain by opportunistically switching assets between cash and the market. This is an attempt to buy securities when they have decreased in price and then sell them when their prices rise. Empirical evidence tends to refute the longer term merits of such a strategy as it can entail frequent and costly trading which is often ill timed and erodes returns. Few investors, be they professional or amateur, are able to achieve success for any appreciable length of time with this approach as a result.

Passive Investing
Passive investing utilizes index mutual funds and exchange-traded funds to gain exposure to various segments of the market. Underscoring this approach is the investor's belief that the financial markets are, for the most part, efficient, and, therefore, rather difficult, if not impossible to outperform. Passive investing can focus on the overall market as well as various segments of it.

The proliferation of exchange traded funds would seem to enable investors to gain cost-efficient exposure to any number of market styles and segments. The benefit of passive investing is its cost-efficiency. Active management involves use of the manager's investment acumen which may or may not be on target and which is more expensive as trading securities is involved. Because such an approach takes what the market has to offer, some pundits would decry what they deem as its blind faith in the efficient market theory, which holds that markets are random and that the surfeit of active management often makes the pursuit of alpha a fruitless exercise.

Additionally, the plethora of ETFs allows investors to gain rapid and inexpensive exposure to various equity and fixed income market segments, as well as to sectors and industries. Investors would do well to understand just what it is that these funds are attempting to replicate and the risk/return trade off of doing so. Some segments of the markets are less efficient than others. Investors should not rely upon passive investing as a panacea for the pursuit of various objectives.

Buy and Hold
A type of passive strategy, the buy and hold approach involves little more than purchasing a mix of assets and holding them.[Perold, André F. and Sharpe, "William F. Dynamic Strategies for Asset Allocation", Financial Analysts Journal, January/February 1988 p. 17]. The portfolio is not rebalanced. To the extent that the portfolio is invested in equities, the potential for price appreciation is unlimited in a rising market. In down markets, this approach will experience less growth, but be cushioned to the extent that it is invested in fixed income and cash. As this approach involves no trading beyond the initial purchases, it is passive and inexpensive.

Portfolio Immunization
Immunization is a fixed-income strategy designed to address interest rate risks, ensuring that the portfolio maintains a yield sufficient to meet any liabilities as they come due. The change in yield can result from a change in market interest rates, either increasing or lowering the value of the portfolio in consequence and possibly hindering the portfolio's ability to satisfy its obligations. Effective immunization entails matching the portfolio's duration to the length of the investment horizon, and making the present value of the cash flow from the fixed income instrument equal that of the future liability.[Fabozzi, Frank J. Bond Markets, Analysis and Strategies, Second Edition Prentice Hall, 1993 Chapter 22 Structured Portfolio Strategies p.535 "To immunize a portfolio's target accumulated value against a change in the market yield, a portfolio manager must invest in a bond (or a bond portfolio) such that (1) the Macaulay duration is equal to the investment horizon, and (2) the initial present value of the cash flow from the bond (or bond portfolio) equals the present value of the future liability."] Bonds are purchased with varying maturities, both lesser and greater than the time horizon of the investor. Rebalancing would need to occur semi-annually to annually. Defined benefit retirement plans utilize immunization to meet the cash flow needs of retirees. The strategy is imperfect, as the conditions for immunization assume a flat yield curve and parallel changes in it (e.g. interest rate increases or decreases are in equal measure in terms of basis points).

Swap and Collar Strategies
Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: Vanguard Total World Stock

    Learn about the Vanguard Total World Stock exchange-traded fund, which invests in stocks located in numerous countries with a high level of diversification.
  2. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  3. Mutual Funds & ETFs

    ETF Analysis: iShares US Real Estate

    Learn about the iShares US Real Estate fund, which holds shares of equity and nonequity real estate investment trusts incorporated in the United States.
  4. Mutual Funds & ETFs

    ETF Analysis: SPDR Barclays Short Term Corp Bd

    Learn about the SPDR Barclays Short-Term Corporate Bond ETF, and explore detailed analysis of the exchange-traded fund tracking U.S. short-term corporate bonds.
  5. Investing Basics

    What to Cut From Your Portfolio Right Now

    Owning stocks may shortly become too scary for your portfolio. Here's why, and here are some alternatives.
  6. Forex Strategies

    How To Avoid Exchange Rate Risk

    What are the best strategies to avoid exchange rate risk when trading?
  7. Investing Basics

    How AQR Places Bets Against Beta

    Learn how the bet against beta strategy is used by a large hedge fund to profit from a pricing anomaly in the stock market caused by high stock prices.
  8. Investing

    6 Reasons Why Every Investor Should Consider ETFs

    Once you understand the benefits of ETFs, you’ll see how they could be an exciting and smart way to help meet your financial goals. Here some key facts.
  9. Investing News

    Oil or Gold: Which Will Recover First?

    Not sure where oil and gold are headed? The answer is complex.
  10. Professionals

    Boomers’ 401(k)s are Way Out of Whack: What to Do?

    Many baby boomers have been investing heavily in equities in their 401(k)s. Now may be the time to rebalance to avoid huge losses if the market tanks.
RELATED TERMS
  1. Net Line

    The amount of risk that an insurance company retains after subtracting ...
  2. Political Risk Insurance

    Coverage that provides financial protection to investors, financial ...
  3. Maximum Drawdown (MDD)

    The maximum loss from a peak to a trough of a portfolio, before ...
  4. Gross Exposure

    The absolute level of a fund's investments.
  5. Priori Loss Estimates

    A technique used by insurance companies to calculate loss reserves.
  6. Value Of Risk (VOR)

    The financial benefit that a risk-taking activity will bring ...
RELATED FAQS
  1. Is my IRA/Roth IRA FDIC-Insured?

    The Federal Deposit Insurance Corporation, or FDIC, is a government-run agency that provides protection against losses if ... Read Full Answer >>
  2. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  3. What are common delta hedging strategies?

    The term delta refers to the change in price of an underlying stock or exchange-traded fund (ETF) as compared to the corresponding ... Read Full Answer >>
  4. How does being overweight in a particular sector increase risk to a portfolio?

    An investor who is overweight in a particular sector risks a loss in value for the portfolio if there is a downturn in that ... Read Full Answer >>
  5. What are the primary risks an investor should consider when investing in the retail ...

    The retail sector consists of companies operating in multiple industries such as specialty retail, general retail, food and ... Read Full Answer >>
  6. What risks do I face when investing in the insurance sector?

    Like all equity investments, insurance companies present investors with market risk. Insurance companies, like banks, also ... Read Full Answer >>
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!