Different Approaches to Investing Money
Derby District & Law Society (D& DLS) magazine – July 2010
Different Approaches to Investing Money
In my last article I detailed the four main stages in the economic cycle and the way that different asset classes perform in each stage. However, the markets are heavily driven by sentiment, resulting in them being overpriced and inflated during the 1990’s and possibly under priced in the early part of 2003 and 2009.
As a result of this there are different investment strategies that some investors use based on the observations made in my previous article regarding the economic cycle and I have detailed these below, along with the main benefits and drawbacks of each:
Buy and Hold. Most investors use this strategy, although they have been disenchanted with it given the significant stock market falls from 2000 - 2003 and 2007 – 2009.
The basic premise is that buying a balanced spread of investments should produce better returns than deposits over the long term and the different types of assets should perform differently in market downturns, offering a cushion from severe market falls. In reality, most investments have been very closely correlated in the recent market turmoil and holding different asset classes was not much help. This strategy does usually involve lower costs than the more ‘active’ approaches.
Market timing. This strategy offers the largest financial rewards, but is also the most difficult to get right.
The idea is to identify when a market is at or near its top, or starting to fall and to sell out completely or even to hold short positions to benefit from the fall. Crucially, it is also important to decide when the market is nearing its low point and when to buy back in. This approach requires the most strength of conviction, as it usually requires a very strong ‘contrarian’ approach.
Taking recent events as an example, few correctly identified the heavy falls that would occur from 2007, or the very strong ‘bounce’ from March 2009 onwards. Also, although some managers identified that markets were too cheap at the end of 2008 or at the start of 2009, many bought in too early and suffered further heavy falls in value before the markets finally started a sustained pick up in March 2009.
There are different variations to this type of approach, including ‘Momentum’ investing, where you steadily invest as markets are rising and start to sell as they begin to fall. This means you are not taking an ‘all or nothing’ approach and trying to time the markets exactly, but it also means you miss out on some growth in rising markets and suffer some losses in falling markets. Crucially, this strategy still has inherent market timing issues.
Active asset allocation. This strategy allocates monies to the most ‘suitable’ asset class.
This approach involves an investment manager identifying which asset class, geographical region or sector is the most suitable to invest into and then they ‘tilt’ the portfolio accordingly. They do not necessarily try to find the best stock to hold in each area, they are more concerned with being invested into the right area. The main issue I have with this approach is that it is only suitable for investors who are happy to have the majority of their monies invested, as although the theory is good, few managers moved sufficiently into cash, when with hindsight it was the best place to be.
A sensible overall plan
Professional Financial Centre (East Midlands) Ltd has successfully helped many clients to put a sensible financial plan into place that will last them for the rest of their lives. When looking at the huge choice of investments available we are able to prove that we only have your interests at heart. We do not have any vested interest in choosing one particular product or course of action over another. As changes happen, we review our clients’ plans, adjusting them to meet changing economic circumstances and family needs. If you want to challenge us to do the same for you or your clients, you will not be disappointed. If you simply want a second opinion, our view on your existing holdings, or have a general query about financial matters, please call us.
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