Understanding different investment styles
When it comes to investing, there’s no one size fits all strategy that can assure success but there are some different investment styles that could help investors achieve their goals.
Growth investing, value investing, momentum investing and dollar-cost averaging – these are some of the common buzzwords used to describe different kinds of investment styles or methods, used by investors to help them achieve their investment objectives. Below, we explore some of the better known styles, what they involve and how they may be helpful to investors on their journey.
A growth investment can be defined as an often younger company that has the potential to meaningfully disrupt or transform a rapidly evolving industry (for example, technology or services). A growth investment is appealing due to its significant future growth prospects and ability to demonstrate an upward trend in earnings and revenue at an above average rate compared to industry peers. Growth companies may prefer to reinvest their earnings back into the business to continue expanding rather than pay a dividend to investors. This means investors tend to make gains largely through capital appreciation if or when the company’s share price rises in future.
By using a growth strategy, investors are looking to the future – investing in companies they believe will significantly exceed market expectations as the “next big thing”. While there is no specific formula for determining a company’s potential, investors may undertake individual research to consider factors such as historical earnings and future earnings potential, cash flow and whether there is sufficient future demand for a company’s products and services. Note that in exchange for a potentially higher investment return, there is often higher risk associated with growth investments (for example, share prices fluctuate regularly, which can make them volatile) as many of these companies are relatively small or new and found in often rapidly evolving industries.
A value investment is generally defined as a company that is undervalued or under priced by the market – often due to market overreactions to bad news regarding a company setback, management change or disruptions to the company’s operating environment. This investment may trade on the share market with a lower share price compared to its intrinsic value – meaning, the company’s share price appears cheaper compared to key financial metrics such as the company’s earnings, debt, performance and cash flow, as well as key fundamental factors such as the company’s brand, business model, target market and competitive advantages.
By adopting a value strategy, investors purchase (and often hold for the long term) shares in what they believe are quality companies at bargain prices with the hope that in time, markets will come to appreciate their intrinsic value – making them more appealing to other investors and, in turn, leading to a rise in share price. However, one of the risks of this strategy is timing. That’s because it can take time for markets to either recognise a company’s value (meaning, some investors later buy shares at a higher price, therefore missing out on the ‘bargain’) or learn that it actually has little value at all (meaning, some investors may have made a loss by having invested in that company).
There are risks for all investments, even traditionally defensive investments such as bonds. A momentum investment is generally defined as an opportunity that allows investors to capitalise on a market trend. This often involves buying an investment as it rises, but selling it before it peaks (or loses momentum). These opportunities are often identified through a data driven analysis of different technical indicators and financial metrics – for example, share price trends over time.
By using a momentum strategy, investors look to take advantage of trends or volatility in markets – surfing one wave and jumping to the next before each wave falls. However, depending on the investment itself and the experience of an investor, some opportunities will be held longer than others. Some of the risks of this strategy include adopting an investment or moving into a position either too quickly or too slowly, as well as missing out on key trends and technical deviations in data.
While other strategies typically involve identifying and engaging with different investments in line with a specific criteria, dollar-cost averaging simply involves investors making periodic investments of a set dollar amount over an extended period of time. In fact, superannuation is a form of dollar-cost averaging, with regular super contributions being invested over time.
By adopting this strategy, investors can not only stay invested but can also capture opportunities across different strategies at different price points. This can mean removing the guesswork often associated with trying to time the market and has the potential to reduce the risks associated with the impacts of market volatility and poorly timed investments on an investor’s portfolio.
Other styles of investing
There are many other investment styles that investors may consider to help them generate returns. These include socially responsible investing, which can involve choosing investments based on their environmental, social or governance fundamentals, as well as income investing, which can involve choosing investments (for example, bonds or shares) that pay a regular income through interest or dividend payments.
Choosing an investment style
While there’s no one size fits all strategy that can assure success, having a strategy could still help investors achieve their investment objectives. It can be important for investors to consider their:
- financial objectives
- changing circumstances
- timeframe for investing
- ability to take on risk in their portfolios
- ability to engage with their strategy.
However, it may also help to speak to a financial adviser who can review an investor’s financial plan and recommend a strategy for them based on their financial goals and personal circumstances.
Source: Colonial First State