What Is an Investment Strategy?
An investment strategy is what guides an investor's decisions based on goals, risk tolerance, and future needs for capital. Some investment strategies seek rapid growth where an investor focuses on capital appreciation, or they can follow a low-risk strategy where the focus is on wealth protection.
Understanding Investment Strategies
Many investors buy low-cost, diversified index funds, use dollar-cost averaging, and reinvest dividends. Dollar-cost averaging is an investment strategy where a fixed dollar amount of stocks or a particular investment are acquired on a regular schedule regardless of the cost or share price. The investor purchases more shares when prices are low and fewer shares when prices are high. Over time, some investments will do better than others, and the return averages out over time.
Some experienced investors select individual stocks and build a portfolio based on individual firm analysis with predictions on share price movements.
Graham's Five Investment Strategies
In 1949, Benjamin Graham identified five strategies for common stock investing in "The Intelligent Investor."
- General trading. The investor predicts and participates in the moves of the market similar to dollar-cost averaging.
- Selective trading. The investor picks stocks that they expect will do well in the market over the short term; a year, for example.
- Buying cheap and selling dear. The investor enters the market when prices low and sells a stock when the prices are high.
- Long-pull selection. The investor selects stocks that they expect to grow quicker than other stocks over a period of years.
- Bargain purchases. The investor selects stocks that are priced below their true value as measured by some techniques.
Graham emphasized that every investor must decide how they want to manage their portfolio. Experienced investors may prefer and be comfortable with a buy low and sell high strategy, whereas investors who have less time to research and follow the market might benefit more from investing in funds that track the market and adopt a long-term view.
There is no right way to manage a portfolio, but investors should behave rationally by using facts and data to back up decisions by attempting to reduce risk and maintain sufficient liquidity.
Investment Strategy and Risk
Risk is a huge component of an investment strategy. Some individuals have a high tolerance for risk while other investors are risk-averse. One overarching rule, however, is that investors should only risk what they can afford to lose. Another rule of thumb is the higher the risk, the higher the potential return, and some investments are riskier than others. There are investments that guarantee an investor will not lose money, but there will also be minimal opportunity to earn a return.
For example, U.S. Treasury bonds, bills, and bank certificates of deposit (CDs) are considered safe because they are backed by the credit of the United States. However, these investments provide a low return on investment. Once the cost of inflation and taxes have been included in the return on income equation, there may be little growth in the investment.