What kind of investor are you? If you don't know, you might have a problem. It's useful to have a handle on your investment strategy, so that you can better focus on it.
There are many different ways to categorize investing. For example, a Goldilocks-like approach might divide investing strategies into these groups:
- Too-aggressive investing: This approach puts your dollars in danger. It can include any of a host of riskier-than-average types of investments, such as options, commodities, currency bets, penny stocks, and even lottery tickets. It's true that some options strategies can be conservative, but many are not, and it's very, very common for options to expire unexercised and worthless.
- Too-cautious investing: It might seem smart to be very conservative with your money, but if you do that, it might not grow enough to support you in retirement. That's especially true these days, in our environment of ultra-low interest rates. With inflation historically averaging about 3% annually in the U.S., even earning 2% in your bank account or via a bond or CD will leave you losing purchasing power over time.
- Just-right investing: For many people, a long-term portfolio mixed with both stocks and bonds is a sound way to grow your net worth.
The bond world features many kinds of bonds, such as government bonds, municipal bonds, and corporate bonds. Government bonds, such as U.S. Treasury bills, bonds, and notes, are the safest, backed by the U.S. government. They pay interest that's taxable on your federal tax return, but is exempt from state and local taxes. Municipal bonds can be riskier, as some local governments are on somewhat shaky ground, but they can therefore offer higher interest rates and their interest is exempt not only from state and local taxes, but also from federal taxes. Corporate bonds are issued by companies that want to raise money. They, too, offer rates higher than government bonds, and their interest is not tax-exempt. In general, the higher their interest rate, the lower their credit rating and healthiness.
Stock investing approaches
A sound stock investment strategy is hard to beat, for long-term growth. Here's a quick rundown of some key approaches. Note that many investors engage in one or more of them -- they're not all mutually exclusive.
- Value investing: This investment strategy involves seeking out stocks that offer a meaningful margin of safety, by being undervalued -- ideally, trying to buy a dollar for 50 cents. Value investors will typically study the fundamentals of a company, such as its growth rates, balance sheet, profit margins, and so on. They may favor a stock such as fertilizer company CF Industries, with its forward P/E ratio below 7 and promising prospects, given our planet's growing population that will need to be fed.
- Growth investing: This involves focusing on fast-growing companies. It can be riskier than value investing, as some growth stocks can be seen as overvalued and many offer little or no margin of safety. Starbucks, for example, has averaged annual growth of 22% over the past 20 years and sports a not-bargain-level P/E ratio of 32.
- Income investing: This investment strategy involves seeking cash payouts from your investments, generally via dividends from common and preferred stocks. Utilities have long been viewed as good dividend payers, but real estate investment trusts have grown in popularity, and gobs of other companies offer long track records of compelling payouts. Shipping specialist Textainer, for example, recently yielded 4.5% and has been growing that payout at double-digit rates.
- Large-cap and blue-chip investing: This involves focusing on the biggest and most established companies around. They're rather proven, if they've grown to a large size, but their growth rates tend to slow as they grow. Many pay dividends, too, as they don't need to plow as much money into growth.
- Small-cap investing: This investment strategy appeals to many folks because small companies have the greatest growth potential. They can be riskier than their bigger counterparts, but they can sometimes be easier to read up on and understand, as their operations are still somewhat focused. Telecom specialist 8x8, focused on high-margin voice-over-IP software, is an example of a stock on the small side. It has averaged annual growth of more than 40% over the past decade, and some still see lots of growth ahead and even wonder if it will get bought out.
- International investing: It's always smart to include international holdings in your mix, for diversification. If the U.S. economy stumbles, stocks based elsewhere may hold up better. You can add considerable global exposure via big American stocks, though, if you like, as many of them generate a lot of money abroad.
- Index investing: Finally, consider index investing, which can include any or all of the above. Index investors don't have to carefully select which small-cap or international or dividend-paying stocks to buy. Instead, they invest in funds that track wide indexes, such as ones that represent the S&P 500 or the total world stock market, or thousands of small companies, or Latin American stocks.
Many roads will lead to Rome. Learn more about your choices in investment strategies and take on the ones that fit your needs and temperaments best. Aim to be balanced, too.
The best investing approach is to choose great companies and stick with them for the long term. The Motley Fool's free report "3 Stocks That Will Help You Retire Rich" names stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of. Click here now to keep reading.