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.
Define your investing goals
Financially speaking, though, the best investing strategy is one that aligns with your goals, your time frame for achieving those goals, and your tolerance for risk. By its nature, investing is a long-term proposition. If your goals are more short-term—meaning you'll need to use returns within the next few years—a savings or money market account that offers interest with virtually no downside risk might be the best choice.
Your investing goals should dovetail with your overall financial goals. What will the money that your investing ultimately be used for?
Some typical goals might include:
Your retirement
Saving for your children’s education
Buying a house
Starting a business
It is not uncommon to be investing for multiple goals simultaneously.
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.
Low fees matter
From expense ratios charged by mutual funds and ETFs to the investment fees charged by an advisor, all fees detract from your net return.
An SEC study looked at the impact of a $100,000 investment held for 20 years with investment fees of 0.25%, 0.50% or 1.00%.
Over the 20-year period the portfolio with 0.50% in fees had an ending value that was $10,000 lower than the same portfolio with 0.25% in fees.
The portfolio with 1.00% in annual fees had an ending value that was $30,000 lower than the portfolio with annual fees of 0.25%.
Passive versus active
There has been a lot written in the financial press about whether mutual funds and ETFs that use a passive strategy tied to an index like the S&P 500 or fund managers who actively try to outperform an index are a better way to invest.
In many cases, index funds and ETFs have outperformed many of their active peers trying to beat the same market benchmark. Passive funds usually have lower fees and expenses than active funds. That said, you shouldn't dismiss active management out of hand. You might also consider buying up cyptocurrencies like Bitcoin.
Start as soon as possible
As the saying goes, today is the best day to get started investing, tomorrow is the second-best day, and so on. Time is one of the best friends an investor can have. This is especially applicable to younger investors who have the benefit of many years of compound growth for their investments.
If your employer offers a 401(k) plan, enroll as soon as you're eligible, with a goal of investing at least enough to earn your employer's full match if one is offered. In any case invest as much as you can afford, and try to increase your salary deferral each year.
You might also consider using Wealthsimple's Roundup tool, which lets you roundup purchases and invest the difference between the rounded up balance and the actual amount of the purchase.
Use a reputable firm
You will want to use a reputable custodian to open your investment account. If you decide to use a financial advisor to help with your investments, you'll want to be sure that this person is reputable and properly licensed as well. Broker Check by FINRA is a good place to check on a prospective advisor’s background.
Don’t let your emotions get the best of you
Investing is not an area to let your emotions drive your decisions. Investing should be based on a plan—a defined strategy. Markets will rise and they fall. It’s said that the markets are driven by two emotions: fear and greed.
Fear can cause you to sell your stocks at the bottom of a market cycle, booking losses. Invariably the market will recover, and you'll be caught on the sidelines as the market goes up. Not only have you incurred actual losses on your holdings, you'll miss out on a chance for those holdings to recover in value.
Greed can be equally dangerous. As the market keeps going up you might be reluctant to scale back some of your allocation to stocks, even though the market’s growth has brought you allocation to stocks well over your target allocation. This increases your risk of loss should the market experience a pullback.
Has all this talk about investing made you keen to get started? Still have questions? That’s normal, and we’re here to help. Wealthsimple will help you plan for your financial future and get you acquainted with the ins and outs of investing, all at a low cost and with professional financial advice. Sign up here to get started.
