Investing is like wearing clothes – you need something that makes you feel comfortable, not ill at ease.
When shopping for the right outfit, you look at the style, the material, the colors, and of course the cost as well.
Likewise, when looking for the ideal investing strategy, you need to assess your objectives, risk appetite or tolerance. There is no one-size-fits-all investment strategy.
However, there are several time-tested portfolio design strategies that you can choose from. Here are five:
This active investing strategy is the epitome of “time-tested.” It is one of the oldest and simplest portfolio design strategies.
In growth investing, the focus is on finding stable, mature stocks with a lot of potential for long-term growth.
The portfolio will consist of around 10 such stocks, carefully picked after considerable time and research. You will have to do a deep analysis of financial statements and company information to find the best stocks.
This is the investor’s version of “bargain hunting,” where you are constantly looking for stocks that are selling below their book value.
Instead of hunting solely for individual stocks, you can also populate your portfolio with a few index funds, ETFs, or mutual funds with a value stock focus.
The approach does have a weakness: Due to a lack of adequate diversification, a common risk level can permeate an entire value stock portfolio. It would be wise to exercise some extra caution if you plan to build your entire portfolio around value stocks.
Core and satellite
In this approach, you build your portfolio around a well-established mutual fund, preferably with a bias towards large-cap equity stocks.
Around this “core,” you allocate smaller portions of your investment to “satellite” funds, with the aim of risk reduction and diversification.
These satellites could be anything — funds with mid-cap or small-cap stocks, foreign stocks, gold and precious metals, money market securities, and more.
Modern Portfolio Theory (MPT)
Diversification is the name of the game here. Just as the philosophy of utilitarianism focuses on the greatest happiness of the greatest number, MPT devotees look for the maximum returns at the lowest possible risk.
You are free to hold any asset regardless of its risk, as long as you balance the portfolio with other, unrelated investments. The MPT approach to portfolio building can accommodate a core and satellite design, as long as you pay enough attention to diversification.
Tactical asset allocation
Finally, we have a mishmash of all the different approaches mentioned so far. Tactical asset allocation involves everything — diversification, active investing, and risk mitigation. In this approach, all the three main asset classes are kept in balance, basically, stocks, bonds, and cash.
A starting point might be 65% assets, 30% bonds, and 5% cash. You will then constantly monitor how these classes are performing, and make suitable adjustments from time to time.
Unlike with a growth focus, you are not tied to individual stocks for the long term, unless their performance stays aligned with your risk and return preferences.