As an investor, you are unique. And as you start building your portfolio, there are many strategies you can draw upon to help you achieve your personal financial objectives. Which you choose will depend on your needs and the goals you are trying to accomplish.
Choosing an Investment Strategy
Say you’re in the market for a new pair of shoes. You’ll likely want to choose something that will last a long time, is a comfortable fit, and doesn’t leave you wondering whether you made a mistake when you bought them.
The shoes should also fit your individual needs—are they for long-distance running, for work, for going out at night?
In many ways, choosing an investment strategy is like shopping for the right pair of shoes. You need one that fits your personal goals, whether those goals are saving for a down payment on a house, a child’s education, or retirement.
And you need a strategy that will be comfortable for you to pursue in the long-term. You don’t want to be tempted to switch strategies frequently, potentially upending your financial plan.
Ultimately, the best strategy (or mix of strategies) is the one that works for you. Here’s a look at some of the fundamental strategies that you may want to consider as you start to build out your investment portfolio for the first time.
Strategies for Building a Portfolio
An investment strategy that splits a portfolio among asset classes—including stocks, bonds, and cash—asset allocation helps strike a balance between investment risks and returns.
Each of the assets classes above behaves differently under different market circumstances, which means each has its own risk and return profile. For example, stocks tend to offer the potential for the highest returns. They can also be volatile, which means in addition to high highs, they may experience low lows.
Cash, on the other hand, tends to be extremely stable. The money in your savings account isn’t likely to go anywhere and might even be insured by the federal government.
Yet, the trade-off for that stability is the fact that savings accounts or other cash equivalents, such as certificates of deposit, offer relatively low returns, typically between 0.01% and 3% APY.
The proportion of each asset class that investors hold is related to their personal goals, time horizon, and risk tolerance. Time horizon is the amount of time an investor has to invest before they achieve their goals, and risk tolerance is an investor’s willingness to lose some of an investment in exchange for potentially greater long-term returns.
Asset allocation might shift over time. An investor in their 20s saving for retirement might have a portfolio made up of mostly stocks. Stocks could offer the greatest potential returns, and with 40 years before the investor might need the money, they may have plenty of time to ride out any downturns in the stock market.
A person who has already retired and needs much more immediate access to their cash may hold more fixed-income investments, like bonds, which are less volatile and therefore less likely to experience hard downturns at the time the investor needs them.
One way to manage risks in a portfolio is through diversification, building a portfolio with a broad mix of investments across assets. Essentially, diversification can help investors avoid putting all their eggs in one basket.
Imagine for a moment a portfolio invested in just one oil stock. If the price of oil goes down, the entire portfolio suffers.
Now imagine a portfolio that holds stocks from all sectors, in companies of all sizes from all around the world. Not only that, but the portfolio holds a variety of bonds and even other investments like real estate.
Similar to asset allocation, the idea here is that these different investments will behave differently during changing market conditions. For example, U.S. stocks may not perform the same as European stocks, and energy stocks may not perform the same as medical company stocks.
With a diversified portfolio, as market condition changes—such as a drop in the price of oil—one group of investments may suffer while another may not, thereby spreading out risk.
Your portfolio can change over time. During a bull market, you may find your stocks are performing well and that they now make up a much greater portion of your portfolio than they did before.
Remember that your portfolio is balanced based on your personal goals, time horizon, and risk tolerance. So when there is a shift in holdings, investors may want to buy or sell assets to bring their portfolio back in line with their planned asset allocation.
Strategies for Buying and Selling
Tax efficiency is a measure of how much of your return stays with you and how much ends up going to the government. Keeping an eye on taxes can be an important part of maximizing your investment returns.
The first step in building a tax-efficient portfolio is to understand where the investments—whether in taxable, tax-deferred, or tax-free accounts—will be held. Taxable accounts include brokerage accounts, and income from these accounts may be subject to long- and short-term capital gains tax and other taxes.
Long-term capital gains tax is a tax treatment applied to investments that have been held for a year or more. Short-term capital gains tax is applied to investments that are held for less than a year and are pegged to an investor’s tax bracket.
Investors looking to minimize their taxes might want to hold on to investments for more than a year to be subject to the longer long-term capital gains rates.
Tax-deferred accounts, such as 401(k)s and traditional IRAs, allow investments to grow tax-free as long as they remain in the account. Investors fund these accounts with pre-tax dollars, and withdrawals made after age 59½ are subject to regular income tax.
Tax-free accounts, such as Roth 401(k)s and Roth IRAs, are funded with after-tax dollars, but investments inside the account then grow tax-free. When investors make qualified withdrawals from these accounts, they pay no additional taxes.
As a general rule of thumb, tax-efficient investments, such as regular stocks, may be held in a taxable account, while investors may want to hold inefficient investments, such as taxable bonds, in accounts that have preferential tax treatment.
Dollar-cost averaging is a process by which investors invest on a regular basis, making purchases regardless of price. For example, an investor might choose to invest $100 a month in an index fund that tracks the S&P 500.
The share price for that fund will likely vary from month to month, though the amount of money the investor uses to buy shares does not. By design the investor buys fewer stocks when they are priced high and more when they are priced low.
This strategy might help investors mitigate buying high and selling low. And because investment is done on a regular schedule with a set amount of money, this strategy is one way for investors to avoid emotional investing.
Buy and hold
Investors who choose to use a buy and hold strategy will typically buy stocks and hang on to them for the long term, regardless of short-term market movement. Buy and hold investors believe that they will achieve some kind of return in the future despite fluctuations in the market on a short-term basis.
Fluctuations in the market are a normal occurrence, but investors may still get nervous and want to sell their stocks at the first sign of a downturn.
However, this tendency can work against investors, as selling a stock locks in any losses they may have experienced and means they could miss out on any subsequent rebound in price. A buy and hold strategy might help curb this tendency.
What’s more, the buy and hold strategy could help investors minimize fees associated with trading, which might help boost the overall return of the portfolio.
Strategies for Picking Stocks
Fundamental analysis is a strategy that can help investors choose specific stocks to buy. When practicing fundamental analysis, investors look at public data like financial statements, revenue, earnings, future growth, and profit margins as well as broader economic factors when choosing a stock.
Fundamental analysis attempts to look at everything that affects a security’s value, including macroeconomic factors like overall market conditions and industry conditions and microeconomic factors such as company management.
Investors hope that a thorough examination of these factors can help them arrive at an intrinsic value for the stock. The price at which the stock is actually trading may be above or below this value, and by comparing this value with the current price, investors could determine whether or not it’s a good time to buy.
Unlike fundamental analysis, technical analysis does not try to identify an intrinsic value of a particular investment. Technical analysts believe that a stock’s fundamentals are already factored into the price of the stock so do not require individual attention.
So, when using this strategy, investors try to identify good investments by looking at statistical trends. For example, investors may look at factors such as price movement and trading volume. By identifying patterns and current trends, investors hope to be able to predict future patterns and trends.
Value investing is a strategy that makes use of fundamental analysis. The basic idea behind this style of investing is that investors only buy stocks that are priced lower than their actual value and hold onto them for the long-term, or at least until they rise above the investor’s price target.
In other words, these investors are looking to buy stocks that are mispriced or priced at a “discount.” If an investor buys a stock at a lower price than they believe it is actually worth, chances may be good that the price of the stock will rise before the investor sells it.
Before buying any asset, investors should be sure to do their due diligence, learning as much about it as they can. In some cases, investors can lean on the expertise of others. Rather than try to identify values of stocks themselves, investors can buy mutual funds, index funds, or exchange-traded funds (ETFs) that hold value stocks that have already been identified by professional fund managers.
While value investors are looking for stocks that are priced less than they are worth, growth stock investors put much less emphasis on the current price.
They are focused on stocks that are likely to increase in value in the future, more so than other stocks in their industry or the market as a whole.
Growth investors tend to focus on young companies that have a lot of growth potential, companies in quickly expanding industries, and those that make use of new technologies and services.
There is no real formula for what to look for when identifying growth stocks. However, investors looking for growth opportunities might want to look at companies that have strong historical earnings growth in the recent past. Investors might also look at forward earnings growth.
Publicly traded stocks must make earnings announcements on a regular basis, and analysts will make earnings estimates shortly before these announcements are made. These numbers can help analysts approximate the fair value for the company.
Once again, investors can leave the analysis up to professionals and may choose to invest in mutual funds, index funds, or ETFs that invest in growth stocks. Investors interested in taking a hands-off approach through investing in funds may consider an automated investing account to help them build a portfolio.
Monitoring Your Portfolio
Your life is not static, and your goals and financial needs will change. For example, you may change careers, get married, have children, decide to retire early or decide you want to work longer than you had planned. Each of these milestones can affect your goals and how much money you need to save.
You could consider SoFi Invest®, which lets you invest however you feel most comfortable, whether that’s hands-on with active investing or letting automated investing do the work for you.
With SoFi Invest, there are no transaction or management fees, and you can speak to a financial advisor at no charge.
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