What is an investment management style?
Also known as an investment philosophy or strategy, an investment management style is the investment portfolio manager’s approach to building a portfolio. It accounts for the specific characteristics used to analyze potential investments and defines how a portfolio’s investment goals will be achieved.
Active versus passive investing
An active investing style is one where investment managers select specific stocks and try to time the market to seek better returns for investors. Actively managed funds typically charge higher fees than passively managed funds.
If you’re comfortable with more investment risk and have a long time until you need to use the invested money, active investing may be for you.
Passive investing is a more “set it and forget it” style. Diversified portfolios are created and left for a longer time to ride the market. For this reason, they often have lower fees.
If you have less comfort with investment risk and can ignore market volatility, passive investing may be for you.
One form of passive investing is index investing. Here, an investor chooses stocks that mimic a particular stock index, hoping their portfolio will perform similarly to the index. This style can be an easy, inexpensive way to achieve a diversified portfolio in the long term.
Growth versus value investing
Growth investing focuses on stocks that offer strong earnings and revenue growth and future growth potential. Growth investment managers may buy stocks at a higher cost, but they see greater return potential. This can present higher potential risk.
Value investing focuses on potential. Value investment managers look for lower price stocks that may be presently trading below what they should be and can offer better potential returns.
Choosing between a growth and value investing style often depends on the investor’s risk tolerance, investment goals and how long they have until they need to use the invested money.
Growth at a reasonable price (GARP) investment managers combine growth and value investing. They look for stocks at a reasonable price, but with growth potential to optimize return and minimize risk. They look for stocks at a reasonable price, but with growth potential to optimize return and minimize risk.
Core investment managers choose both growth and value stocks that generally represent the overall market without favouring growth or value stocks.
Top-down versus bottom-up investing
Top-down investment managers focus on the big picture. They first examine overall economic conditions and market trends. Then they look at industries, sectors and countries which may benefit from the economy improving. Finally. they find the companies in those industries, sectors and countries that meet the fund’s objectives.
Bottom-up managers analyze individual companies, and not necessarily the direction of the overall economy. They look for potential within a company and buy stocks to reflect their fund’s objective. They prefer to wait for the absolute best price on stocks.
Some investment managers blend both styles, using a top-down approach to choose the industry, sector or country and a bottom-up approach to buy the specific company stock.
Large-cap versus small-cap investing
This investment style focuses on choosing stocks based on a company’s size or their market capitalization (cap for short) which is determined by multiplying the number of outstanding shares the company has by their earnings per share. You can find this information in their annual report or possibly on their website.
Small-cap companies have a market cap of $300 million to $2 billion. Large-cap companies have a market cap of over $10 billion (for example Microsoft, Google, or Amazon).
Small-cap investors believe smaller companies provide more opportunity for growth and are more flexible. However, this potential comes with increased risk because smaller companies may have fewer resources and less business diversification. Their share prices can fluctuate more widely, causing bigger gains or losses. Small-cap investors must be comfortable with additional risk to tap into a potential for greater returns.
Large-cap investors choose companies that have been around for a while. Although they may not be able to grow as quickly because they’re already huge, they also aren't as likely to go out of business. Large-caps investors can expect slightly lower returns than with small caps, but less risk, as well.
Dividend growth investing
Dividends are paid by companies to their shareholders based on the number of shares they own. They’re usually paid when a company has excess cash they’ve not reinvested into the company. They divide this excess cash among shareholders.
Investors who are retired or retiring soon may choose to switch to investments that can provide dividend income when they’re no longer working. Dividend growth investing may be a way to achieve this goal.
How dividends work
Qualified shareholders are notified of a dividend through a press release which often includes:
- The declaration date – the date the dividend is declared
- The record date – when a company reviews the shareholder list to determine who may receive the dividend payment
- The payment date – the day shareholders will receive the dividend
- The ex-dividend date – if you purchase shares on/after the ex-dividend date, you’re not eligible to receive the upcoming dividend
Choosing dividend growth investments
Here are a couple of factors you can use to choose dividend growth investments.
- Payout ratio – The dividend payout ratio relates dividends to a company’s earnings and may indicate the sustainability of its dividend policy. If their payouts are 55% to 75%, more than half their earnings are going towards dividends, rather than being reinvested. If the ratio is 10% to 30%, it could indicate the company is putting its earnings towards growth.
- Past trends – Look at a company’s recent dividend payouts. Have they doubled during the last couple of years or slowly declined? Have they remained steady or constantly increased and decreased?
When a company that usually pays dividends drastically reduces dividend amounts, or eliminates dividends completely, it may signal something about the company’s financial health. Or it might suggest the company plans to reinvest that money into growing the company.
That’s why you should research a company before you invest in it. Reading their annual report and website can help you understand their business model and growth plan. There’s no guarantee that a company will pay dividends.
Risk tolerance comes down to your comfort level and preferences and your real-world financial situation. It’s important for these 2 areas to line up. If you’re very willing to take risk, but unable to recover from market drops, you could run into challenges.
Once you determine your risk tolerance, you’ll be able to recognize the type of investor you are.
- Conservative – Your risk tolerance and capacity are lower. Your investments will ikely include fewer stocks and more bonds or money-market assets (which usually offer steady returns with less fluctuation in price).
- Moderate – You might be somewhere in the middle, perhaps someone with a higher risk tolerance but a lower risk capacity. Your investments might include a mix of stocks and bonds for a more balanced approach. Moderate risk investors are often attracted to managed funds with large-cap, blue chip securities or a value investment style.
- Aggressive – You have a higher risk tolerance and capacity and accept that you might see big swings in your investment value over time. You’re likely looking for bigger potential returns. Your investments are likely mostly stocks (as opposed to bonds) from big and small companies. In some cases, your investment choices could choose international, high-growth stocks and emerging markets.