What is an investment strategy?
An investment strategy is a method of building your investment portfolio.
It’s how you decide what to invest in, how much to invest, and for how long. It’s a plan to help you achieve your goals, and to help you make decisions that will maximize your return on investment.
There are many different investment strategies, and the 1 that’s right for you will depend on factors, such as:
- If you’re investing to meet short-, medium- or long-term goals
- Your risk appetite
- How much money (also called capital) you’re able to invest
Because these and other factors differ from person to person, there are many different strategies that might be a fit for you. Whichever you choose, it will likely fall into 1 of 2 categories – active or passive investing.
Active versus passive investing
Active investing takes a hands-on approach, meaning your portfolio is “actively” managed by a fund manager. That could be yourself or a professional you ask to manage your investments for you. With this approach, you buy and sell often, keeping up with news and trends.
On the other hand, passive investing involves buying and holding investments over the long term. Passive investors are less interested in the day-to-day fluctuations of the market as they are the long-term potential of returns, and as such, they don’t buy and sell daily (known as “trading”).
There are pros and cons to each style of investing:
- It needs expert analysis and someone to regularly keep up with news and market data.
- In addition to paying transaction fees, you may also pay commission to your portfolio manager or analyst, which can eat into returns.
- As managers can buy any investment they think will bring high returns, they’re still subject to daily market fluctuations and crashes, so this approach requires a higher risk-tolerance.
- It's ideal for a beginner, as there’s little day-to-day portfolio management required.
- As there’s less trading involved, there’s less to pay in fees, making it a cost-effective way to invest.
- This approach is suited to those with a lower risk tolerance.
Types of investment strategies
Buy and Hold
With this type of investment strategy, an investor buys stocks to hold for the long term. Instead of trading daily to try to capitalize on market trends, you hold onto your assets and ride out the ups and downs of the market. This pursuit of long-term returns over short-term volatility is the opposite of daily trading and is a form of passive investing.
Less trading means fewer fees, making it an economical way to invest. As you hold your investments over the long term, they may be impacted by market volatility. This is a part of normal and healthy market behavior. Just like seasons, the timing of these cycles are unpredictable and so the best course of action is to be prepared. There are strategies for dealing with market ups and downs which you can follow to ensure you haven’t taken on too much risk and can help you focus on what matters when your news feed is filled with scary messages about struggling markets.
Dollar Cost Averaging (DCA)
DCA refers to investing regular amounts of money in regular intervals, regardless of market performance. The idea is that by buying regularly in markets that are both high and low, investors can build a portfolio by buying a higher volume of shares when price are low, and fewer shares at higher prices.
Let’s look at an example. Let’s say you set up $100 from each paycheque to automatically be contributed into an investment account. If this month a stock trades at $10, you’d buy 10 shares. If it jumps to $15 next month, you’d buy 6.
DCA can help prevent emotional investing or the temptation to “buy the market” and helps build discipline over time. On the other hand, you may continually contribute to a poor stock choice if you don’t frequently review your investments.
If you’re a member of a workplace savings plan, you can automatically contribute from your paycheque to your group savings plan.
When a company turns a profit, it can distribute some of this money to its shareholders (the people who own stock in the company). These payments are known as dividends, which can be paid regularly or as a lump sum. With this investment strategy, you or your portfolio manager buys stock that will pay dividends, which usually means investing in stable, established companies with a history of strong performance.
Let’s look at an example. You’ve invested in a company that pays a 2% dividend per share, and you own 5 shares worth $100 each. You’d receive a dividend of $2 per share, for a total of $10.
When done successfully, dividend investing can provide you with another income stream on top of your return on investment. Of course, you’ll need the company to turn a profit for this strategy to work, and you’ll need to report and possibly pay tax on dividend incomeOpens a new website in a new window.
You may have heard of the Dow Jones, the NASDAQ or the S&P/TSX (Standard & Poor 500/Toronto Stock Exchange) here in Canada. These are all market indexes, also called market indices, and they track the performance of stocks, bonds and other investments to measure their performance. An index fund is a type of mutual fund or exchange-traded fund (ETF) with a portfolio that’s made to match that of a market index.
These ready-made funds contain assets that are spread out over a wide range of industries to provide broad market exposure, and usually have low management fees. Essentially when you buy an index fund, you’re buying lots of small shares in hundreds of companies, which is great for a beginner investor or someone who doesn’t have a large amount of money to start investing.
Index investing involves buying and holding these funds, with no need to worry about stock-picking or actively managing a portfolio. While there are these and other benefits to index investing, it’s important to remember that index funds will simply follow stock indexes in good times – and in bad times - so there’s little protection against market volatility.
Growth investing is an active strategy to invest in companies that show potential for growth in coming years. Analysis may include financial statements, board structure, the type of industry and other metrics that can indicate a company is poised to grow, succeed and turn a profit.
A famous example of a growth stock is Apple (AAPL). When they started publicly trading in 1980, shares were just $22! Anyone who’d bought shares back then would have seen significant growth on their investment in the decades since.
If you’d bought any of these stocks in the early days, you’d have enjoyed high returns, so investing in companies that are full of potential now means you may well benefit from strong growth later.
However, for this strategy to succeed, you’ll need to commit a huge amount of time to research. Even with all that analysis, there’s still a risk you’ll pick a company that looks poised to grow but doesn't reach its potential.
Usually, successful investing means beating the benchmark index - in other words, doing better than a stock market like the S&P/TSX. But this way is difficult to connect investment progress with reaching your goals. With goals-based investing, you’re aiming to do more than just beat an index, but rather build a strategy that considers the different time horizons, order of importance and the suitable risk levels for your financial goals. Managed portfolios like Constellation can help you invest to help you reach life goals such as saving for a child’s education, a vacation, or any other milestone.
Value investors pick what are known as “value stocks”, or stocks that are trading for less than their book value. These are usually companies that have reliable business models and generate steady gains over time.
The stock market reacts to good and bad news, but the changes to the price of a stock may not necessarily reflect its long-term fundamentals to be a strong performer. In this case, you’d buy the stock at its lower price with the belief the price will rise once the market corrects itself.
Let’s look at an example. Let’s say you’ve wanted to buy a stock worth $100, and a morning when the market dips, you decide to check its price. It has fallen to $70, so you buy 1 share anticipating the stock will at minimum return to its book value of $100, making you a $30 profit when it does. In a few months' time, the market has recovered, and the stock price is now worth $125. Instead of just making a $25 profit, because you bought it at $70, you’ve now made a $55 profit.
Like growth investing, value investing requires a lot of financial analysis for this strategy to work successfully. If you pick the right stock, there’s potential to see substantial profit over time. However, this strategy requires patience, as you not only have to wait to buy when the market dips, but also for the correction to occur to see if that stock price will recover. If the stock doesn’t recover as expected, you may not make as much profit as you’d hoped.
When it comes to taxes, not all investments are created equal.
In non-registered plans, different kinds of investments receive different tax treatments. For tax purposes, investment income falls into 1 of 3 categories:
- Interest income - In non-registered plans, different kinds of investment income receive different tax treatments.
- Dividend income - Dividends earned on Canadian stocks qualify for a dividend tax credit. As a result, Canadian dividends are taxed at a lower rate than interest income.
- Capital gains - Capital gains (proﬁts from the sale of investments) are also taxed at a lower rate than interest income because they have a 50% income inclusion amount.
Registered savings products such as Registered Retirement Savings Plans (RRSP) and Tax-Free Savings Accounts (TFSAs) typically give you a signiﬁcant tax advantage over non-registered savings. Income earned within a TFSA is totally tax-free even on withdrawal. Taxes on income earned within a RRSP are deferred until the money is withdrawn from the RRSP.
Another thing to think about when choosing your investment strategy is whether you want to diversify your portfolio.
Diversification is a strategy to help reduce risk. It involves spreading your money out over lots of different asset classes and investment types such as bonds, stocks and real estate. The idea is to essentially not put all your eggs in 1 basket, but to spread them out so that they’re not exposed to the same risks. That way if something happens to impact the value of 1 sector or stock, you have others that may not be affected.
How to decide on an investment strategy
There’s no one-size-fits-all approach to investing, so deciding which strategy is right for you depends on several factors. To get an idea of what might be best for you, start by asking yourself a few questions, such as:
Why am I investing?
There are many reasons why people invest money. One of the main reasons is to pay for retirement, but there are pre-retirement goals such as paying for a wedding, buying a house, or paying for a child’s education. Deciding what you want to do and how much you’ll need to do it will play a big part in your investment strategy.
How long do I want to invest?
When determining your goals, you should look at whether it’s a short-, medium- or long-term goal you’re trying to achieve. How long you plan to be invested will help decide the asset exposure of your portfolio, something that will also depend on how you feel about risk.
What’s my risk appetite?
Risk appetite refers to how much risk you’re willing to take as markets fluctuate over time. Investing always comes with an element of risk, and your portfolio will experience gains and losses over time. How much risk you’re willing to take will depend on things like your life stage, how much you’ve invested, as well as your personal comfort levels with risk. There are 3 main risk appetites in investing:
Aggressive – An aggressive investor has a high tolerance for risk and is willing to “lose big to win big”. This means you’d be willing to risk losing money if it meant you could potentially see better returns overall. Generally speaking, these investors have a good understanding of the markets and a high level of financial literacy, preferring to invest in stocks over bonds.
Moderate – A moderate investor is comfortable with a balanced approach to risk, wanting to grow their money but without risking huge losses. They may create a portfolio that has a 50/50 mix of stocks and bonds.
Conservative – A conservative investor has a low appetite for risk, wanting to limit any volatility and prevent losses from occurring. These investors will opt for low-risk investments in exchange for modest gains to try and protect their investments from market fluctuations.
There are varying levels between these 3 categories, and your appetite will likely change over time. For example, when you’re starting out investing and/or are young, you have time to recuperate any losses from market volatility or downturns, and you may have less in the way of financial commitments at this stage of life. In this case you may want to build an aggressive portfolio to maximize gains.
If you’re closer to your investment goal and therefore closer to accessing the money you’ve invested, you may not have as high of an appetite for risk as a result. Now may be the time to build a more conservative portfolio instead.
Avoiding emotional investing
If you’ve picked an active investment strategy, 1 thing to try to avoid is emotional investing.
Emotional investing refers to investing based on emotions like excitement, greed or fear.
Studies have shown the average investor gives into excitement, jumps on the bandwagon and buys a stock when it’s performing well (in other words, they buy high). When the price drops, that same investor often gives in to fear, panics and sells the stock (they sell low).
Having a plan in place can help you avoid this type of emotional thinking and stay invested for the long term. In fact, giving into those emotions can be risky in and of itself. A plan can also help you proactively address the risks that come with investing, so you can focus on long-term growth without letting your emotions lead the way.
How managed solutions can help
Perhaps you’re keen to start investing but unsure about which strategy to choose and how to go about doing things yourself. In these cases, a managed portfolio could be the right choice for you.
With managed solutions, you don’t need to pick an investment strategy, as a professional does it for you. They’ll select a diverse mix of equities, fixed income, and cash in order to protect your money against market swings, while handling the day-to-day management of the fund. Everyone’s situation and goals are different, so there are several options available to help you find the best fit for you and your family.
Investing through your workplace savings plan
Another way to begin investing is to contribute to your workplace savings plan.
There are many different plans available, which may provide you with lower fees than you’d find at retail institutions, tax advantages as well as top-ups in the form of employer contributions (where applicable). As you can contribute directly from your paycheque, it’s an easy way to start investing your money without having to select a strategy yourself. If you’re a member of a Canada Life group savings plan, visit your online account to learn more.