Investment Strategy

Investment Strategy: A Clear Guide to Maximising Returns

An investment strategy is a set of rules, procedures, or behaviours that guide an investor’s selection of an investment portfolio.

The strategy is designed to achieve an individual’s profit objectives, taking into account their unique skills and risk tolerance.

It involves making choices that involve a tradeoff between risk and return, with most investors falling somewhere in between and accepting some risk for the expectation of higher returns.

The time horizon of investments is also an important consideration. Investments such as shares should be made with a minimum time frame of five years in mind.

It is recommended that individuals keep a minimum of six to twelve months’ expenses in a rainy-day current account before investing in riskier investments than an instant access account.

Additionally, it is recommended that no more than 90% of an individual’s money be invested in non-instant access shares to prepare for unexpected expenses. In the absence of income, income can be created by using share income funds.

Strategies

Investors employ various investment strategies to achieve their financial goals. Here are some popular investment strategies:

  • No Strategy: Investors who don’t have a strategy are often referred to as Sheep. They make arbitrary choices modeled on throwing darts at a page, which is called Blindfolded Monkeys Throwing Darts. However, this strategy is not recommended as it has debatable outcomes.
  • Active vs Passive: Passive strategies like buy and hold and passive indexing are often used to minimize transaction costs. Passive investors don’t believe it is possible to time the market. Active strategies such as momentum trading are an attempt to outperform benchmark indexes. Active investors believe they have better-than-average skills.
  • Momentum Trading: This strategy involves selecting investments based on their recent past performance. Stocks that had higher returns for the recent 3 to 12 months tend to continue to perform better for the next few months compared to the stocks that had lower returns for the recent 3 to 12 months. However, there is evidence both for and against this strategy.
  • Buy and Hold: This strategy involves buying company shares or funds and holding them for a long period. It is a long-term investment strategy, based on the concept that in the long run, equity markets give a good rate of return despite periods of volatility or decline. This viewpoint also holds that market timing, that one can enter the market on the lows and sell on the highs, does not work for small investors, so it is better to simply buy and hold.
  • Long Short Strategy: A long short strategy consists of selecting a universe of equities and ranking them according to a combined alpha factor. Given the rankings, we long the top percentile and short the bottom percentile of securities once every re-balancing period.
  • Indexing: Indexing is where an investor buys a small proportion of all the shares in a market index such as the S&P 500, or more likely, an index mutual fund or an exchange-traded fund (ETF). This can be either a passive strategy if held for long periods, or an active strategy if the index is used to enter and exit the market quickly.
  • Developed Markets vs Emerging Markets: Many people use developed stock markets because they are believed to be safer than emerging markets. When investing globally, you have the risk of changes in currency exchange rates on top of stock market performance. Other people pick emerging markets believing the emerging markets have higher potential for GDP growth which in turn would then affect positively the share prices in those countries. Emerging stock markets can be less well-regulated than those in the developed markets increasing risks and have greater political risks associated. The most common way of investing in global markets is through funds.
  • Pairs Trading: Pairs trade is a trading strategy that consists of identifying similar pairs of stocks and taking a linear combination of their price so that the result is a stationary time-series. We can then compute Altman_Z-score for the stationary signal and trade on the spread assuming mean reversion: short the top asset and long the bottom asset.
  • Value vs Growth: Value investing strategy looks at the intrinsic value of a company, and value investors seek stocks of companies that they believe are undervalued. Growth investment strategy looks at the growth potential of a company, and when a company has expected earning growth that is higher than companies in the same industry or the market as a whole, it will attract the growth investors who are seeking to maximize their capital gain.

    Be careful of value traps. This is where stocks have good P/E ratios or NAV’s (net asset values) because the stock or sector is not predicted to do well into the future by the investor public e.g. in a declining market. It can also happen if a company’s past performance has not been good in the past after a sharp selloff.

  • Dividend Growth Investing: This strategy involves investing in company shares according to the future dividends forecast to be paid. Companies that pay consistent and predictable dividends tend to have less volatile share prices. Well-established dividend-paying companies will aim to increase their dividend payment each year, and those who make an increase for 25 consecutive years are referred to as a dividend aristocrat. Investors who reinvest the dividends are able to benefit from compounding of their investment over the longer term, whether directly invested or through a Dividend Reinvestment Plan (DRIP).
  • Dollar Cost Averaging: The dollar cost averaging strategy is aimed at reducing the risk of incurring substantial losses resulted when the entire principal sum is invested just before the market falls.
  • Contrarian Investment: A contrarian investment strategy consists of selecting good companies in a time of down market and buying a lot of shares of that company to make a long-term profit. In a time of economic decline, there are many opportunities to buy good shares at reasonable prices. But