The Investors' Dilemma - Investment Strategy Part 5

The third part that we need for developing your Investment Philosophy is your Investment Strategy. There are two clearly defined strategies for investing; one associated with each of the specific market beliefs.

The first strategy we will discuss is Asset Class Investing which employs an investment methodology that is consistent with the belief that markets work.

The second strategy is Speculative Investing, otherwise known as Active Management. This approach is aligned with the belief that markets fail.

There are three tenets for each of these investment strategies. The Asset Class Investing strategy is built on the tenets of Market Returns, Asset Allocation, and Lifelong Investing. On the other hand, the Speculative Investing strategy is based on Stock Selection, Track-Record Investing, and Market Timing. Let’s examine each of these strategies in more detail.

Asset Class Investing refers to a buy and hold approach to asset management. If you think markets work efficiently, then buying and selling securities in an attempt to outperform the market is effectively viewed as a game of chance rather than skill. Instead of trying to forecast the future, this approach involves applying scientific, academically proven strategies of Modern Portfolio Theory.

Three tenets of Asset Class Investing are:

Market Returns

Use structured or index-type funds to deliver market returns for the asset classes in the portfolio.

Asset Allocation

Expose the portfolio to multiple types of investments including: equities and fixed income instruments, domestic and international markets, and growth and “value” investments, to provide maximum diversification and correlation effects. The goal is to maximize returns for a given level of risk.

Lifelong Investing

A step beyond “long-term,” investing is seen as a lifelong process. Instead of attempting to get in and out of the market at the “right time,” staying in the market all of the time is a fundamental part of success in Asset Class Investing.

Speculative Investing or Active Management means actively buying and selling securities with the assumption that securities bought are worth more than the price paid, while securities sold are worth less than the selling price.  According to Webster’s dictionary, “speculation” means buying and/or selling in the hope of taking advantage of an expected rise or fall in price.  Active management is analogous to speculating in the market.

Three tenets of Speculative Investing* are:

Stock Selection

Pick stocks that will get high returns in the future and invest in them.  This technique can be implemented in both individual stocks as well as within other investment vehicles, such as mutual funds.

Track-Record Investing

Utilize an investment’s previous performance to determine whether or not to invest in it for the future. 

Market Timing

Any attempt to alter or change a portfolio based on a prediction about the future.

*These three tenets are the most commonly used and accepted tools of investing among retail investors. They are associated with the term “investing,” and are portrayed extensively in all forms of media—magazines, books, Internet,  news, radio, commercials, banks, Wall Street, etc.

To escape the Investors’ Dilemma it’s critical to pick an investment strategy and to align it with your Market Belief.

When we have market beliefs that are inconsistent with our investment strategy, the result is confusion, anxiety, and often despair. But when our investment strategy and our market belief lines up, then the result is internal confidence. We have a renewed sense of control and a lasting peace of mind.

On your journey toward peace of mind it’s going to be crucial to align your investment strategy and your market belief once and for all. What is your Investment Strategy?

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Paul Nichols

The Investor Coach