The stock market with all its promise can be brutally unrewarding for the beginner and even seasoned investors.
I know people, buddies of mine, with advanced finance degrees who dived into the murky waters of the stock market, to put it simply, they lost a lot of capital.
And gave up investing in stocks entirely, culpriting the high level of uncertainties surrounding the market.
Most people that get burnt trading stocks tend to dive into the stock market hurriedly, treating it like a gamble house, well, the stock market is not a casino.
Every successful stock investor has a defined guiding principles that influences their investment decisions.
Warren Buffett and Benjamin Graham are renowned value investors, Thomas Rowe Price Jr was a successful and renowned long-term growth investor, Peter Lynch was a successful investor who combined both growth and value investing strategies, and the list goes on and on.
Without this guiding principles, picking stocks becomes a Hail Mary affair, throwing muds at the wall and hoping it sticks.
There are things one need to know and do before investing in stocks. And one of the most important is choosing an investment strategy and sticking with it.
In order to succeed in the stock market you need to be guided by time-tested investing principles.
What is a Stock Investment Strategy?
A stock investment strategy is defined as a set of principles, guidelines, behaviours, and rules that are designed to systematically drive an investors stock-picking decisions.
It helps investors/portfolio managers to allocate capital effectively, in order to meet their investment goals, factoring risk tolerance, investment objectives and time horizon.
Adopting a stock investment strategy is critical as it increases the old of consistently picking winners, building a portfolio that thrive despite market volatility, and effectively managing risks associated with market uncertainties.
Here are the things you need to consider before adopting an investment strategy:
1. Your investment goals
Investment goals are targets to aim for when investing, they are often personal and strives to achieve an investor’s “big picture” of objectives of their capital.
Investment goals tends to answer the question “to what end are you investing?”.
As such it is not surprising that not everybody invest simply to make as much money as possible.
Some people are looking for investment vehicles to preserve their money and tend to be risk-averse.
Others invest in companies to support or promote a cause while expecting returns on their investments in the process.
So before adopting an investment strategy, ensure it is best suited to help you achieve your investment goals.
2. Risk Tolerance
Investments are risky in nature, stock investing is equally as risky as it is rewarding.
You need to establish the level of risk you can tolerate. This will help you determine what stocks to consider and to avoid.
For every company you invest in, there is the potential for rewards and the risk of losing money.
If you cannot tolerate losing 50% of your capital within a relatively short period of time for the promise of doubling your money within the same timeframe, you obviously need to stay away from high-rewards high-risk strategies like momentum trading.
3. Time Horizon
Time horizon is a fixed point in the future that you will need to achieve your investment goals and access the money tied up in your stock portfolio.
When investing in stocks you are tying up capital for the promise of a accruing interest on your capital.
Typically, the longer your money is tied up, the more interest you will potentially accrue.
Using our investment calculator, we calculated that if you invest $1000 per month for 10 years with a 10% annual rate of return you will gain $81,458 in Interests.
And if you did the same for 20 years, you will gain $483,987 in Interests alone.
Obviously, you’d make a whole lot more over a longer period of time but not everybody wants their money tied up for 20 years, for so many personal reasons.
Determining how long you are okay with tying up your money is critical to choosing your stock investment strategy.
Some strategies are best suited for short-term investments and others for long-term investments.
4. Management Style
Generally, there are two types of stocks portfolio management styles; active and passive investing styles.
Active investing requires stock portfolio managers to carry out research and analysis of individual stocks, frequently make buy and sell decisions based on this extensive analysis, and keep track of their performance with the goal of outperforming a define standard benchmark (I.e. beat the market).
On the other hand, passive investing requires way less buying and selling activity, as such, significantly less research and analysis are required, and tends to be long-term oriented.
Passive investors just buy and hold for the long haul, whether they invest in an individual stock or a basket of stocks.
And in the middle are investors, like me, who combines both passive and active investment styles to achieve their investment goals.
Key thing to keep in mind is that active investing style can potentially offer higher returns within a relatively short period of time but historically passive investing style outperforms over an extended period of time.
5 Proven Stock Investing Strategies
Here are 5 time-tested stock investing strategies to consider:
1. Value Stock Investing
Value Stock Investing is an investment strategy that focuses on stocks that are trading at prices that are valued less than their “true value”.
Value stocks are underappreciated by market participants making them trade at discounted valuations. Value investors invest in them with the hope that when market participants come to appreciate their true value share prices will rise.
This investing strategy was popularized by legendary investors like Benjamin Graham and Warren Buffett.
“What gives you opportunities is other people doing dumb things”Warren Buffett
In the search for bargain deals, value investors carry out extensive research and analysis of individual stocks relying on key metrics such as price-to-book ratio, price-to-earnings ratio, forward price-to-earnings ratio, debt-to-equity ratio, and enterprise value to cash from operation (EV/CFO) ratio to determine a company’s true intrinsic value.
In bear markets, when everybody is fearful and tend to make dumb decisions (i.e. panic selling of really good companies at a substantial discount), the hunting season for value investors peaks.
During the 2011 debt ceiling crisis, for instance, when everyone was dumping financial stocks, Warren Buffett invested $5 billion in Bank of America (BOA), and by 2017, 6 years later, the BOA investment more than tripled in value.
This before accounting for the dividends paid out to Warren Buffett’s Berkshire Hathaway during the 6 years period.
Advantages of value investing
- It’s a Low-Risk High-rewards Strategy: Value Investing offers the potential for high reward with a relatively low risk of losing money given that value stocks are inherently trading at a discount to begin with. This is a favorable investment strategy for people who are risk-averse.
- Stable Returns: By nature value stocks are less volatile and have the potential of delivering a more stable return year-after-year. This makes it suitable for investors who can’t handle the wide volatility, heavy paper losses associated with high-risk stock investment strategies.
- Compound Interest: Value stocks generally pay dividends. Investors can tap into the power of compound interest by reinvesting the dividends into buying more shares of the company.
- Long-term capital gains: Value stocks has the potential for long term wealth creation. Over the long-run value stocks tend to deliver huge capital gains for investors as such it is ideal for long-term buy-and-hold investors.
Drawbacks of Value Investing Strategy
- Value trap: This is the biggest drawbacks of value investing strategy. Value trap is a stock that seems undervalued based on all key value investing metrics such as price-to-earnings ratio or debt-to-equity ratio but fails to appreciate after a prolonged period of time. In worst cases, value investors lose money as a share price declines further.
- Takes Time: Value investing is time consuming. From the amount of time it takes to carryout research and analysis of thousands of companies in search for a value stock, to the period of time value investors need to wait before investment record significant upside. It is simply not an investing strategy for investors who seek fast returns or who are not willing to put in the hours.
2. Growth Stock Investing
Growth stock investing is an investment strategy that focuses on buying shares of companies with high revenue or earnings growth potential.
Growth companies usually operate in fast-growing industries or are growing faster than their peers in the same sector.
Investors who buy growth stocks are playing for high long-term capital appreciation as a result of the company’s rapidly growing business.
This investment strategy was popularized by legendary investors like Thomas Rowe Price Jr, Philip Fisher, and Peter Lynch.
Growth stocks by their very nature are high-risk investments with the promise of market-beating returns.
They are usually small caps or start-up stocks dominating or playing a leading role in a rapidly expanding or emerging-market.
“Maybe you are right five or six times out of 10. But if your winners are up 4 or 10 or 20 fold, it makes up for the ones where you lost 50% 75% or 100%”Peter Lynch
Identifying a good growth stock requires extensive research and analysis.
Growth investors are guided by the key growth metrics/indicators such as earnings per share (EPS) growth, revenue/sales growth, profit margins and strong return on equity (ROE).
Growth stocks can double, triple or even 10x an investors capital within a relatively short period of time and that is why they are favoured by investors chasing significantly high returns on their investment.
Checkout: 3 Growth Stocks to Boost your Portfolio
In recent times, Tesla, a standout example of growth stocks, saw its share price rise over 16,000% since its IPO in 2010.
A $10,000 investment in TSLA when it IPOed would be worth over $1.6 million today.
Returns like this are life changing and that’s why growth investors don’t mind the risks of losing lots of money in pursuit of insane returns.
Advantages of Growth investing
- High potential return: Growth stocks provide investors with the potential for market-beating returns; significant capital appreciation.
- High long-term performance: Over the long-run growth companies can go from leading an emerging market to leaders in an established market, producing significant capital gains for investors over time. Growth investing is a favourable investment strategy for long-term investors.
Drawbacks of Growth investing
- High Volatility: Growth stocks are highly volatile they can experience huge swings and stock prices and are not suitable for investors with lyrics tolerance and a shorter time horizon.
- Growth trap: Growth investors typically pay a premium price when buying shares of growth companies and these companies fail to meet up with the high expectations of investors, the stock’s price drops significantly. Last year when Netflix, a growth stock, reported an unexpected shrinking subscriber base, its stock price plummeted by 35% in one day.
Past performance does not guarantee future performance, growth investors buying shares of growth companies at the premium price could suffer brutal losses when they disappoint.
3. Index Fund Investing
Index investing is an investment strategy that focuses on buying a “basket of stocks” that tracks the performance of a specific market benchmark (index) as closely as possible.
It is the ultimate passive stock investment strategy. Index investors don’t need to carry out research and analysis of individual stocks, they simply just buy and hold index funds.
Index funds are investment funds [mutual funds and exchange-traded funds (ETFs)] that seeks to replicate the performance of a specific market index.
Popular stock market indexes includes the S&P 500 index, the Dow Jones Industrial Average, NASDAQ composite, the Russell 2000, and the Wilshire 5000 Total Market index.
Index investing was popularized by John Clifton Bogle, the founder of the Vanguard Vanguard group. Instead of trying to beat the market, index funds strives to be the market.
John Bogle’s rational surrounding index investing is best summed up in his argument “don’t look for the needle in the haystack, just buy the haystack”.
Index funds typically have fund managers who buys all the stocks that the index tracks and ensures it captures the returns of the index as closely as possible, and these managers charge a low fee for their services.
Advantages of Index Fund Investing
- Beginner-friendly investment strategy: Index investing is one of the easiest ways to invest in the stock market. Index investors need no expertise, with index funds everybody can get started investing in the stock market successfully.
- Diversification = Low Risk: Index investing is a low risk approach to buying stocks. The potential downside is relatively low as index funds typically contains diversified individual stocks, thereby, spreading your risk through more exposure.
- Lower Cost: With index investing there is no need for extensive research and analysis. Fees are generally low, the savings from lower risk adds up substantially over time.
- It is a passive investing strategy: Index investing is an autopilot route to investing in stocks. You don’t need to be stressed about making buy and sell decisions, if you don’t have the time or expertise.
- Excellent long-term track record: Over the past 30 years the S&P 500 index has delivered a compound annual average growth rate of 10.7%. Going by historical data, index investing is a reliable long-term investment strategy.
Drawbacks of index Investing
- Doesn’t beat the market: Index investing strategy does not seek to beat the market since its aim is to be the market. Returns over time will closely resemble market’s performance. As such, it is not a good strategy for investors looking for market-beating returns.
- Follows market fluctuations: Index investing strategy is not designed to avoid losses during a down market, they go down with market. Hence, there is an inherently short-term downside risks associated with index investment strategy.
4. Dividend Stock Investing
Dividend stock investing is a stock investment strategy that focuses on companies that pay dividends to shareholders.
Dividend investors make money through two sources of returns: dividend payments and capital appreciation.
Using this investment strategy, investors can leverage the power of compound interest by reinvesting their dividend income into buying more shares of the company through a dividend reinvestment plan (DRIP).
Companies have been paying dividends to shareholders since 1602 when the Dutch East Indian company started paying regular dividends.
Most companies that pay dividends are usually established profitable companies and generally, they are low-risk stocks.
This investment strategy appeals to investors looking to generate positive cash flow from their investment.
It is more suitable to retirees or people planning for retirement seeking a risk-averse and liquid instrument that provides a stable income.
Dividend investors rely on key dividend investing metrics such as dividend yield, dividend payout ratio, EPS, cash dividend payout ratio, and price-to-earnings ratio in order to identify good dividend stocks.
A good dividend stock portfolio consist of stocks that pay above-average dividend yields while maintaining steady stock price growth.
Advantages of Dividend Stock Investing
- Positive Cashflow: Dividend investing strategy offers investors a ‘dependable’ income stream that they can rely on to handle financial needs.
- Low-risk strategy: Dividend investing is a relatively low-risk strategy as companies that pay dividends are usually established and profitable. Plus investors can potentially recoup their the initial investments through dividend payouts.
- Capital appreciation: It is important to note that share prices of dividend stock can and do appreciate; dividend stocks has upside potential.
- It is the ultimate Compound interest strategy: Dividend investors can choose to reinvest their dividend payout into buying more shares, thereby, boosting their potential return on investment.
Drawbacks of Dividend Stock Investing
- Dividends are not guaranteed: Companies paying dividends can simply decide to stop paying dividends completely because they are not obligated to by law. They can also decide to slash the amount they pay out as dividends irrespective of their dividend payout history or track record.
- Low capital appreciation: Most dividend stocks tend to record slow growth in their stock’s price, as such the potential capital appreciation is limited.
- Dividend tax: Dividend income are not tax-free. You should expect to pay up to 20% in taxes each year on your dividend income.
5. Socially Responsible Investing (SRI)
Socially responsible investing is an investment strategy that focuses on companies that are making positive social and environmental impacts that aligns with an investor’s personal values and have the potential to generate positive financial returns for investors.
If you are interested in using your money to impact the world around you positively, based on your personal beliefs without sacrificing potential return on your investment then socially responsible investing is for you.
Socially responsible investing strategy also know an impact investing strategy is not a philanthropic endeavour, investors expect returns on the Investment.
Unsurprisingly, not everybody wants to make money at all cost, for some of us, how we make money is more important than how much will make.
And socially responsible investing strategy enables us reflect our core beliefs into our store portfolio.
Socially responsible investors don’t invest in companies who operate in controversial industries like adult entertainment, gambling, predatory lending, alcohol and tobacco, and fossil fuels.
Socially responsible investing requires extensive research and analysis of stock fundamentals and company’s value.
Although our individual value system differs, when it comes to socially responsible investing, the 17 sustainable Development goals (SDGs) set by the United Nations can serve as key guidelines to consider.
Some of these metrics includes reduce racial inequalities, responsible consumption and production, gender equality, and affordable & clean energy.
Most successful companies in the US stock market have strong sustainability track record. Investors won’t find difficulty in identifying a good stocks using SRI strategy.
According to Morningstar, socially responsible investing funds has gone five times over the past decade.
Investors can also simply invest in socially responsible index funds that matches their core values if stock picking is not their strong suit.
Advantages of Socially Responsible Investing
- Social and environmental impact: The key advantage of social responsible investing is that it allows you bring your humanity into investment decisions. So you can use your investment to impact the world around you while also getting substantial ROIs.
- High capital appreciation: Numerous studies shows that social responsible investment strategy can perform as well as traditional investment strategies.
Drawbacks of Socially Responsible Investing
- Under-performance risk: If the categories of stocks you are avoiding are the high-performers in the market, you will be missing out on the potential gain.