If you are new to investing, getting started can be overwhelming. However, taking the time to learn the basics of investing can go a long way to building a successful portfolio. The first place to start is to understand who you are as an investor, and what is the proper amount of risk you are comfortable taking. Once you have done that it becomes easier to align the right investment strategies to your personal risk profile. This way, you will always act in your best interest instead of chasing a trend that may not suit your needs. That is how a lot of new investors get burned.
All investments contain risk in varying degrees with higher risk investments providing better returns. Unfortunately, there are no online calculators or cookie-cutter, one-size-fits-all methodology to assess your risk tolerance.
While there are universal factors such as age, income and existing capital that help determine how much risk you may willing to tolerate, everyone – even with similar circumstances – have different thresholds of risk they are willing to accept. There are three basic financial risk profiles:
Cautious – avoids risk; fears loss of capital; invests in cash and government bonds
Prudent – manages risk; risk tolerant; moderately increases risk to achieve goals; in corporate bonds and mutual funds
Risk Taker – embraces risk; utilizes high risk to achieve goals; predominantly invests in stocks, ETFs and options
The truth is that most people are a combination of these various risk profiles, and that is perfectly fine. There is no one “correct” level of risk tolerance.
It is a matter of personal comfort with a blend of the risk profiles and investment allocations. There is an old saying that you “invest to the point where you can sleep at night.” Often the body tells the truth that the mind ignores!
That said, generally the younger you are, the greater your disposable income or the larger your current level of savings and investments are, the more risk you may tolerate. This is because you have more time and capital to overcome market declines.
As these factors change over time, your risk tolerance will adjust also. Those with average to above average risk tolerance should be more in stocks and mutual funds rather than low risk investments like corporate bonds, government bonds or cash.
The key to this step is striking the correct balance between where you are in your financial life, what your goals are, and how much risk you are willing to bear in order to achieve those goals.
Once you have identified your risk profile, the next step is to figure out the best “tools” to utilize. These tools are the numerous investment strategies available, plus the multiple and various avenues available to implement these strategies.
If you follow the financial news or delve into investing websites, there seems to be a multitude of investing strategies, some complex and indecipherable. In order to differentiate (and sell) many “strategists” add their own modification, thereby “creating” a new strategy. But take courage, my friend! There are truly only a handful of basic investment strategies. They are Value, Growth, Income, ESG and Balanced.
Value investing emphasizes fundamental analysis to identify an undervalued stock compared to the company and industry historical measures and trends.
This strategy tends to have a long-term outlook as the investor waits for the company’s valuation to normalize. Value investing works best in rising interest rate and moderate-to-down economic environments as investors seek market risk protection.
Growth Investing is looking for stock price appreciation that comes from the expectation of above average revenue and profitability growth. This growth expectation is the key to the Growth strategy. It does not worry about the current stock price or current fundamentals.
Where Value investing looks to the past to predict future gains, Growth investing relies on future profit forecasts to determine present value. These portfolios are weighted towards disruptive stocks, innovative stocks and emerging market companies found in Large, Mid and (mostly) Small Cap sectors.
Growth investing can often include riskier stocks. These are stocks that may have zero revenue at all. Investors could jump in purely because they are trending and the hype is pushing the price higher.
If you are risk adverse, make sure you are taking a close look at which growth stock you are getting into.
Income investing depends upon securities – stocks and bonds – that provide a steady flow of income in the form of dividends or interest payments. These investments provide a reliable income stream with minimal risk. This strategy is not as concerned with price appreciation or market movements as it is with a regularly generated income.
Environmental, Social and Governance (ESG) investing sets standards of corporate behavior to determine which companies to invest in. These companies must be considered stewards of nature; they must treat their employees, customers and suppliers with fairness and dignity; and they must have leadership and management philosophies and policies that promote and sustain diversity and equality throughout.
Previously, many successful companies inherently followed the ESG standards. However, there is a growing demand from without and within the investment community for all companies to explicitly state their support and practice of these standards. ESG investing seeks companies that do good and do well.
The Balanced Investment strategy is a blend of some or all the other four strategies to provide the best mix to match with your goals, available funds and risk tolerance. A Balanced investment strategy portfolio also minimizes risk through diversification by spreading your investments to different risk exposures. As investors progress through their financial life, the balance between risk and return versus income and safety shifts. Understanding these different investment strategies will help make your portfolio allocations easier.
Like investment strategies, you also have multiple avenues to put those strategies to work. You can work with a full-service, traditional broker. You can use an online broker. Or you can download a trading app. A simple analogy to understand the basic differences is trying to get somewhere by Uber, e-bike, or walking.
In an Uber you put in your destination (goal) and the driver, algorithms and car take care of the directions (strategies) and motoring (implementation). On an e-bike, you figure out the destination and directions, but you get some help with the motoring. When you walk, you do it all!
The avenue you choose to invest through depends upon your investment knowledge, the amount of time and effort you are willing to invest into your wealth creation, and how you feel each strategy aligns to your risk profile.
If you want a full-service broker to handle your portfolio, you should research the various firms and interview several brokers. Ask questions about strategy, costs, performance and references. You need to be comfortable with and trust the person and their firm with your hard-earned money.
If you choose an online broker, understand any fees or restrictions associated with trading, holding or moving your funds. And if you are using a free trading app, understand the risks and restrictions associated with your account. Also, this choice is not permanent, and you may change brokers or apps as necessary. When it comes to your money, you need to be an educated consumer as well as an educated investor.
There is inherent risk in each investing strategy but taking the time to understand who you are as an investor will make it an easier time deciding what path and strategy is right for you.