Investment Strategies (part A)
by
Charles Lamson
Investing is an active use of your money to accomplish certain goals. These goals may be short, medium, or long range, and most investors will have one or more from each range.
An investment strategy is simply a plan of how you are going to accomplish your goals and what tools will be needed for the job.
There are two main components besides the amount of money available of any investment strategy:
We are going to spend the next few posts looking at risk and its relationship to reward in much more detail. Risk tolerance is your emotional reaction to risk and how much risk you can tolerate before investing becomes painful.
The simple formula for risk is "the higher the potential reward, the higher the risk." Notice in this formula that the reward is conditioned as "potential," while the risk is certain. You must take the risk without any certainty of success.
How much risk are you willing to take to possibly reach your goal is the essence of risk tolerance.
Your Role
There are almost as many names for investment strategies as there are people talking about them. Everyone seems to have a different way of looking at the same process.
Like just about everything else we have explored so far, investment strategies are multilayered. The first decision regarding investment strategies involves what role you are comfortable with and willing to play in the process.
These are the two roles you have to consider:
As the names suggest, these roles define how involved or uninvolved you are in the decision-making process. Either role is perfectly acceptable and will have about the same chance for success.
The real world is never just black and white, and neither is investing. Most people end up taking both roles at some point in their investing experience.
The Passive Role
The passive role turns most of the decision-making over to the professionals with periodic checkups on performance. Your 401(k) retirement plan is one variation of the passive role.
You may choose how to allocate your investment among several choices, then professionals, usually mutual fund managers, take it from there. You may make adjustments in the allocation from time to time, but you pretty much turn over control to professional managers.
Another example of the passive role is the selection of index mutual funds for your primary investments. An index fund is a fund that seeks to mimic the performance of certain stock market indicators. Its goal is to match the market.
The most popular of these index funds are those which track the S&P 500. These funds are as close to autopilot investing as you can get. If you have neither the time nor the interest in regularly monitoring your investments, index funds are for you.
The Active Role
Investors with the time and inclination often want a more hands-on approach to their investment program. They want to pick their own mutual funds and/or individual stocks.
Their goal is to beat the market, and they use aggressive tools to accomplish their goals. Actively managed mutual funds are more attractive to them than index funds. Even though index funds can and do beat actively managed funds, they do not beat them all.
Investors interested in a more active approach are generally more risk tolerant and willing to look at more aggressive plans.
Taking an active role in your investment requires some discipline and commitment of time. It is important to be honest with yourself. If you do not have the time or commitment to do some homework, you are better served with a passive approach to investing.
Whether you choose the active or passive role in investment decisions, you still need to decide on a strategy (or strategies) for reaching your goals. The amount of time you have to reach your goal and your tolerance for risk suggest a strategy for each investment goal. We will look more closely at investment strategies in the following posts. To be continued...
*SOURCE: ALPHA TEACH YOURSELF INVESTING IN 24 HOURS, 2000, KEN LITTLE 217-221*
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