There’s no one-size-fits-all best investing strategy—everyone’s needs and goals are different. But there are some basics that most investors should consider when building their investment strategy. You can win and lose when it comes to investing, but a big part of defining winning and losing is determined by your overall financial goals.
Investing according to your values
Many funds and some ETFs incorporate approaches that use socially responsible investing (SRI) screens. Others may invest according to the principles of Halal. ESG screening has gained a lot of popularity in recent years. These screens will rank companies based on their scores in dealing with environmental, social responsibility and corporate governance issues. Many studies have shown that companies with good track records in these areas often tend to do better financially than those dealing with issues in these areas.
Time horizon
If you’re 30, retirement is likely 30 or more years in the future. All things being equal, a longer time horizon allows you to take more investing risk since you have ample time to make up losses from the market corrections that will inevitably occur over time.
A longer time horizon also allows investors to take advantage of perhaps the biggest single tool available, compounding. There are numerous studies that show the advantages of starting to save and invest for a long-term goal like retirement as early as possible. This allows the investor to take advantage of the “magic” of compounding their gains over time.
Risk Tolerance
Risk tolerance is your ability to weather losses in your portfolio. While nobody likes to lose money, investors should take into account that the stock market will decline from time-to-time.
Your risk tolerance should be aligned with the time horizon of the goals you are trying to achieve. A longer-term goal like retirement allows you to take a bit more risk since you have time to recover from losses. A shorter-term goal like buying a house over the next couple of years does not allow for a lot of downside risk and your investments tied to this goal should reflect this.
Diversification
Diversification is a key concept when building an investment strategy. Diversification means that your portfolio should be divided among different investment types or styles like stocks, bonds and cash. Within these broad categories, there are a number of sub-styles.
One way to diversify your portfolio is to invest in stocks within the U.S. as well as those based outside of the U.S. Another way to diversify is to invest in companies of different sizes, or market capitalizations. Market cap is the stock’s share price times the number of shares of the company’s stock that is outstanding. Large cap, small cap, and mid cap are typical divisions among stocks based on size. Examples of U.S. large cap stocks include many household names like Apple, Microsoft, and Warren Buffet’s Berkshire Hathaway.
Another way to diversify is by investing in various financial products. Stocks, bonds, and cash react differently based on different economic factors. For example, the price of a bond moves inversely with the direction of interest rates. News of the Federal Reserve potentially increasing interest rates will hurt bond investors, all things being equal. On the other hand, bonds tend to be less volatile in terms of their price movement over time as compared with stocks. The correlation of large cap U.S. stocks with bonds is both low and slightly negative. This type of analysis is often used by professional investors in constructing a portfolio.
For individual investors, using managed investment vehicles like mutual funds or ETFs often makes more sense than investing directly in individual stocks and bonds. These funds can provide the opportunity to invest in a broad array of stocks or bonds within the fund versus having a concentrated position in just a small number of holdings. There are mutual funds and ETFs that invest in all of the asset classes listed above and many others. Using funds is an easy way to build a diversified portfolio for even small investors. Diversification is built right in.