Investing is a powerful tool that allows you to put your money to work to help you reach future financial goals. But if you’re new to investing, you may be asking yourself what strategies should you pursue?
Here’s a guide to help you get started.
5 Popular Investment Strategies for Beginners
1. Asset Allocation
Once you’ve opened an investment account and you begin to build your portfolio, asset allocation is one of the most important strategies to consider to help you balance risk and return. A typical portfolio might divide its assets among three main asset classes: stocks, bonds and cash. Each asset class has its own risk and return profile, behaving a little bit differently under different market circumstances.
For example, stocks tend to offer the highest gains, but they are also the most volatile, presenting the most potential for losses. Bonds are generally considered to be less risky than stocks, while cash is the most stable. Cash investments in your savings account are insured by the federal government.
The proportion of each asset class you hold will depend on your goals, time horizon and risk tolerance. Your goal tells you how much you need to save. Your time horizon is the length of time you have before reaching your goals. And your risk tolerance is how willing you are to accept losses in the short-term in exchange for potentially greater long-term gains.
Your asset allocation can shift over time. For example, someone in their 30s saving for retirement has a long time horizon and may have a higher risk tolerance. As a result their portfolio may contain mostly stocks. As that person ages and nears retirement, their portfolio may shift to contain more bonds and cash, which are less risk and less likely to lose value in the short-term.
Another way to manage risk in your portfolio is through diversification, building a portfolio with a broad mix of investments across assets, helping you avoid putting all your eggs in one basket.
Here’s how it works: Imagine you had a portfolio consisting of stock from one company. If that stock does poorly your entire portfolio suffers.
Now imagine a portfolio consisting of many stocks, from companies of all sizes, sectors and parts of the globe. Not only that, it also holds other investments, including bonds. Now, if one stock suffers, it will have a much smaller effect on your overall portfolio, spreading out the risk of holding any one investment.
Your portfolio can change over time, shifting your assets allocation and diversification. For example, if there is a bull market and stocks outperform, you may discover that you now hold a greater portion of your portfolio in stocks than you had intended.
At this point, you may need to rebalance your portfolio to bring it back in line with your goals, time horizon and risk tolerance. In the example above, you may decide to sell some stock or devote new investment funds to buying more bonds.
4. Buy and Hold Strategy for Investing
Market fluctuations are a natural part of the market cycle. However, investors may get nervous and be tempted to sell when prices drop. However, when they do, investors lock in their losses and often miss out on subsequent market rebounds.
Investors practicing buy-and-hold strategies tend to buy investments and hang on to them over the long term, regardless of short-term movements in the market. Doing so can help curb the tendency to panic sell, and it can also help minimize fees associated with trading, which can boost overall portfolio returns.
When it comes to these taxes, whether a holding is a long-term investment vs. short-term one can make a big difference in terms of how much you pay in taxes.
If you profit from an investment after owning it for at least a year, it’s a long-term capital gain. Less than that is short-term. Capital gains tax rates can change, but generally, longer-term investments are taxed at a lower rate than short-term ones.
5. Dollar-Cost Averaging
Dollar-cost averaging is a strategy that helps individuals invest on a regular basis by making fixed investments on a regular schedule regardless of price.
For example, say an investor wants to invest $1,000 every quarter in an ETF that tracks the S&P 500. Each quarter, the price of that fund will vary—Sometimes it will be up, sometimes it will be down. The amount of money the individual invests remains the same, so they are buying fewer shares when prices are high, and more shares when prices are low.
This strategy can help individuals access a lower average share price, and it can also help them avoid emotional investing.
Investing is an ongoing and dynamic process. Your life, goals and financial needs will all change as your circumstances do. For example, may you get a raise at work, get married and have a child, or you decide to retire early. Factors like these will change how much money you need to save and how you invest. Monitor your portfolio and make adjustments as needed.
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Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.