If you haven’t already, subscribe to our newsletter here to get our articles delivered directly to your inbox and follow us on Twitter, Instagram, and YouTube! In our Educational Series we will be taking a deep dive into different ways to invest your money in hopes that one or multiple of these methods strikes you as interesting and encourages you to invest your money to grow your wealth.
In our previous article titled “Stock Investing Basics,” we broke down the different types of stock investments available to most traders, including exchange traded funds (ETFs), mutual funds, and single stock investing. We’re also releasing new videos on investing basics on our YouTube channel - we will be releasing these videos sporadically, so be sure to subscribe and sign up for notifications here!
There are an infinite number of ways to structure your portfolio. One of the first steps to take when considering how you will structure your portfolio is to understand your risk tolerance. There is always risk involved in investing - the markets are massive, with a huge number of variables (and a lot of noise) impacting stock prices. As an investor, you need to be able to tolerate risk, but you can structure a portfolio in a way that fits your own personal risk tolerance. Here are examples of relatively low, medium, and high risk tolerance portfolio considerations:
Relatively low risk tolerance: index funds that track the S&P 500 tend to return, on average, ~7-10% per year. While these returns may seem modest, they more than compensate for inflation (most of the time) and sure as hell beat the 1% returned in a “high yield” savings account. Additionally, index funds tend to provide exposure to a large number of assets. In the case of the S&P 500, you essentially get exposure to 500 different companies - this is great, because if one company’s price drops, other companies included in the index may rise and negate the drop. Thus, index funds provide investors with built-in diversification. These features make index funds relatively low risk investments. And if you’re extremely low risk, consider investing in a global markets index fund, which can provide exposure to companies spanning the entire globe (it’s unlikely that the entire global economy will collapse).
Medium risk tolerance: There are plenty of ways to structure a portfolio that mix “risky” and “safe” assets together. For example, you may allocate 20% of your portfolio to individual stocks in the hopes of investing in individual companies that you believe will outperform the market as a whole (making them more profitable investments compared to a market index fund). The other 80% of your portfolio can then be allocated to lower risk assets like index funds. In a nightmare scenario, suppose the 20% of your portfolio crashes because you chose to invest in companies caught running a ponzi scheme. In this scenario, losing ~20% will sting, but at least you haven’t lost everything and you can be relatively sure that 80% of your portfolio will continue to give you positive returns. In essence, the low risk component of your portfolio is acting as a hedge against potential failure of the high risk component of your portfolio.
Relatively high risk tolerance: If you have high risk tolerance, you may choose to invest 100% of your portfolio in individual company stocks. Perhaps the riskiest portfolio would be one composed of stocks of only a single company. If that company were to fail, your portfolio would crash.
I am not a financial advisor so I cannot advise you which way, but I can share my stock investing strategy. I currently have about 50% of my portfolio in various ETFs (in the S&P 500 and some of ARK Investing’s ETFs, sadly ARKs haven’t done as well this year as 2020) and 50% in single stock picks. Warren Buffett famously challenged hedge fund managers to beat the S&P 500 index fund for a 10 year time frame and surprisingly, or maybe unsurprisingly, no one was able to do it. I believe everyone can beat the S&P if they invest some in single stocks, but single stock picking is difficult compared to just buying and holding ETFs.
Another important thing to consider when constructing your portfolio is how much time you’d like to put into doing your own research. Similar to risk tolerance, you can construct a portfolio that fits your time preferences. Index funds are relatively passive (i.e., do not require much time), as they are single investment vehicles with built-in diversification and average solid returns. This limits the amount of time you need to spend researching individual companies. They also help limit the amount of time spent trading and/or thinking about trading - if you have exposure to an entire market, you need only stay up-to-date on the state of the market. If, however, you’re invested in ten individual companies, you must stay up-to-date on each company and re-evaluate each position in cases of major news.
For individuals looking for passive and low risk investing, ETFs are a good bet. If you’re up for the challenge of investing in individual companies, there are several common strategies you could employ. Below, I break down a few common stock investing strategies: value investing, growth investing, momentum investing, and dollar cost average investing.
What is value investing?
Value investors attempt to use financial data to analyze companies and ultimately determine their intrinsic value. I firmly believe we are all value investors at heart. When you value invest, you are essentially investing in companies that you believe are undervalued (priced at values lower than you believe the company’s stock is worth). Why would you invest in a company if you didn’t believe their stock value would rise? Value investing has been made popular by investors like Warren Buffet, who used the method to build incredible wealth.
What is growth investing?
While value investing tends to revolve around what a company has already done, growth investing tends to deal more with what you believe the potential earnings of a company could be. This strategy has become particularly popular amongst tech investors. Many large, household name technology companies like Uber, Airbnb and many more, have not yet made a profit but continue to rise in value on the stock market. Value investors may look at historical financial data (e.g., lack of profits) and dismiss these companies (will not buy stock). Growth investors, on the other hand, look at these companies and believe that they will grow and eventually earn profits (and will thus buy stocks). This strategy is speculative in nature and usually carries a higher risk but higher reward.
Now tell me about Momentum Investing.
Momentum investing is exactly what it sounds like: ride the wave of stocks that are going up and jump ship on the ones that are going down. This is not necessarily a day trading strategy, but rather a strategy where you believe in the underlying fundamentals of a business but wait until the stock price starts to rise before investing to ensure that the market believes in the company as well. Momentum investors could run into the issue of buying too early when seeing an initial bump to a stock as well as selling too soon at the first downturn. This comes with trying to understand why a stock price is increasing or decreasing, and sometimes the market is unpredictable. Thus, successful momentum investors rely heavily on timing the market, which is an incredibly difficult thing to do.
I think I’ve heard of Dollar Cost Averaging, but what is it again?
Dollar cost averaging (DCA) is probably the simplest strategy to implement because it is not concerned with the current stock price. With the DCA strategy, investors continually invest into ETFs or stocks they believe will rise in value over long time periods (that is, assets that they believe have strong fundamentals). The general idea of DCA is that you occasionally buy stock when it is overpriced and occasionally when it is underpriced - over time, these tend to balance out. DCA investors generally like to invest in ETFs or index funds, purchase stocks at regular intervals (e.g., once per month or quarter), and tend to hold assets for long time periods.
There’s plenty of additional information on all of these strategies, but in this week's educational article we wanted to keep it brief. In the coming weeks we’ll continue to provide financial education. If you have any questions/comments, feel free to reach out and we can cover that topic! Remember the best time to start investing was 10 years ago and the second best time is today! There are ways to start investing with as little as a dollar, so you can get started now!
Finish out the week strong!
Brandon and Dan
The article was written by Daniel Kuhman and Brandon Keys, and it expresses the author's own opinions. The information presented in this article is for informational purposes only and in no way should be construed as financial advice or recommendation to buy or sell any stock, asset, or cryptocurrency. Brandon and Daniel are not financial advisors. We encourage all readers to do further research and do your own due diligence before making any investments.