How to build an investment strategy

An investment strategy is the set of rules and behaviors that you can use to reach your financial and investment goals. Choosing an investment strategy can be a difficult task when you start learning about investments and finance. Here we will look at the larger overall strategies rather than very specific strategies. Given that this is such a broad term, there can be strategies that go from the top (Overall Portfolio Strategies) to the bottom (stock-picking strategies). You can decide on a strategy that starts with an overall strategy and then choose more specific strategies (top-down approach) or similarly you can look at a specific strategy and choose the overall strategy that goes with it (bottom-up approach). What is important to note is that a strategy can include several strategies, methods and tools. Making one strategy does not always mean that another strategy cannot be used together. The most important thing is to find your own strategy and familiarize yourself with all the different strategies and financial tools available so that you can make a decision that suits you well.

Choosing an investment strategy

Strategies

Given the huge number of strategies and variations within strategies, we will only review common strategies. The level of risk for most is heavily dependent on the type of investment being made, rather than the strategy itself. The most popular strategy used by most investors who would go to a bank or investment firm, for example, is a mix of diversification and asset allocation. Random selection: Picking a large amount of random stocks has proven, on average, to be more successful than the vast majority of trading strategies. Follow: Involves following whatever stock is “hot” at the time. Buy and Hold: Simply means buying stocks and holding them for a longer period of time. Day trading: Considered a rather risky trading strategy of buying and selling many times in a day to take advantage of fluctuations in the market. Contrarian: Means doing the opposite of the current market sentiment. Buying when everyone is selling and selling when everyone is buying. Cyclical: Involves trying to time the ups and downs of the market and trading accordingly, usually using technical analysis. Technical: Using technical analysis to make decisions. Fundamental: Using Fundamental analysis to make decisions. Income: Finding assets that provide income on a regular basis (like dividends) Growth: Finding assets that will have high potential growth but little current income. Diversification: Choosing a wide range of stocks or assets to reduce risk. Asset allocation: More of a guideline than a strategy, which can help determine the right investment amount for each asset type. As we’ve seen, even a buy-and-hold strategy can be incredibly complex depending on the specific strategy you use and the level of analysis. What’s important is to tailor your strategy with what you are trying to accomplish. Someone who needs money right away but is risk-seeking and has a fair amount of knowledge might consider day trading to be a very viable option. Similarly, someone who has decades to invest and moderate risk aversion may still want to try their hand at day trading.

Passive versus active

Overall strategies can also be divided into passive and active categories: Passive strategies are just that, passive. After making the initial decision to buy a stock, investment, etc. the passive investor will hold it for months or years without making major changes. An example of this is someone like Warren Buffet who usually holds stocks for long periods of time and does not make changes to his holdings very often. However, the active trader will trade several times a week or even per day and will constantly evaluate what he is doing. Day traders are the most obvious example of an active trader. It is important to note that passive and active trading are across a spectrum, so someone who makes a few adjustments to his portfolio a few times a week may still be considered passive depending on the size of his portfolio, for example.

Liquidity, risk and potential return

All investments balance liquidity, risk and potential return. The balance between these three areas depends on your own individual tastes, but how you view them will determine the type of investment you choose. 1. Liquidity: Liquidity refers to how easily and quickly an asset can be converted into cash without losing its value. High liquidity means the asset can be sold quickly at a reasonable price, while assets with low liquidity may take longer to sell or may require a discount to attract buyers. 2. risk: In the investment context, risk refers to the degree of uncertainty about the possible outcome. High-risk investments have a greater chance of losing money, but they may also offer higher potential returns. Low-risk investments are generally more stable and reliable, but they tend to yield lower returns. 3. Potential return: Potential returns are the possible gains or profits that an investor can earn on an investment. Investments with higher potential returns are usually associated with greater risk, as there is more uncertainty about whether the investment will actually result in a profit. Conversely, investments with lower potential returns are usually less risky but also have limited profit potential.

Don’t put all your eggs in one basket

Diversifying your investments is crucial at different levels, not only between asset classes but also between sectors. Start by allocating your assets between different security types. For example, a classic approach involves investing 50% of your savings in real estate, with the remaining 50% split between stocks and bonds. That way, if house prices fall, your investments in shares and bonds can provide some protection. Similarly, if the stock market falls, your real estate and bonds can help stabilize your portfolio. Bonds are generally safer investments because their value is tied to prevailing interest rates, making them less susceptible to market fluctuations. They can also be beneficial during a rise in house prices, share prices and interest rates, further reinforcing the importance of diversification.

Use a changing portfolio

The traditional advice to invest in “more bonds as you get older” comes from the belief that your portfolio should become more conservative as you approach retirement. The idea is to minimize the risk of your money as you approach retirement age. If your shares lose value when you’re 25, you have about 40 years to recover the losses before you retire. But if your stocks decline in value when you’re 62, it’s much more challenging to make up for that lost income, emphasizing the need for a lower-risk investment strategy in later years.

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