An investment strategy is the way you select the investments within your portfolio. The investment strategy you pick impacts everything from the institutions and platforms you invest with, what asset types you buy or sell, the taxes you pay, and much more. Your strategy helps you define and meet your financial goals and grow your wealth while maintaining a level of risk that works for your life.
Investing in the stock market (or real estate for that matter) is much more than picking the ‘perfect’ asset, buying it, and then hoping your bet pays off. Smart investors have a strategy that guides them as they make investment decisions.
Here are six reasons you should look into investment strategies and pick the right one for your portfolio. After this quick read, you’ll be on your way to growing your wealth and achieving financial freedom.
- An investment strategy helps you demystify your current financial situation
You cannot decide on the best investment strategy without first taking an honest look at your entire financial situation – especially if you’ve never made a financial plan before.
The two major components to successful investing is figuring out your goals and risk tolerance. To figure these out, you need to know your cash inflows and outflows. What percentage of your take-home pay is left after fixed expenses like rent and loan repayments? Can you invest 50% of your discretionary income? Questions like these are the first step in coming up with a cohesive investment strategy.
- An investment strategy helps you clarify your future goals
Like we mentioned above, an investment strategy is dependent on your goals and the future life you envision for yourself. Do you want to retire early or in a different country? Do you want to start your own self-funded business? Do you want to own properties?
When creating an investment strategy, you have to write down what you are seeking to accomplish. This helps you narrow down (sometimes to the exact year and dollar figure) your future. Stating that you simply want to make money or become wealthy is not helpful. The more specific the objective, the better. This is where you can utilize SMART goals to make this work a little easier.
- An investment strategy evaluates your risk-taking profile
All investments are risky to some degree. Some asset types are ‘riskier’ than others, but usually have higher expected returns to compensate investors for their risk. If you are new to investing – whether it be stocks, bonds, or mutual funds – it’s important to understand before you invest that you could lose some or all (however improbable) of your invested money.
The reward for taking on risk is the potential for a greater investment return. If you have a financial goal with a long-time horizon, you are likely to make more money by carefully investing in asset categories with greater risk, like stocks or bonds, rather than restricting your investments to assets with less risk, like cash equivalents. On the other hand, investing solely in cash investments may be appropriate for short-term financial goals. However, do remember that even with all your money in cash or cash-equivalents, you would be exposed to inflation risk, which is the risk that inflation will outpace and erode value over time.
- An investment strategy keeps you from making emotional or rash moves
When people deviate from their investment strategy to chase ‘fad’ or meme stocks, or decide to overexpose themselves to cryptocurrency, they can end up in unanticipated trouble. The truth is, if you’re seeing these names and assets everywhere you turn (especially social media), the asset is probably already priced too high.
Whatever investment strategy you pick, whether it’s indexing or value investing or growth, you should stick to it long term and ride through all the ups and downs. Not only does this save you from high fees and transactional costs, your portfolio will thank you in the long run.
- An investment strategy helps you keep a long-term focus
When you’re investing in the stock market or real estate, it’s important to note that you’ll see the most value over a medium to long period of time (5-15 years). By keeping a long term focus, you can invest in higher-yielding instruments like stocks and real estate funds.
Long-term savings goals, such as retirement, can handle the fluctuations of the market. Since those investments will be in the market for longer — provided the investor can stay the course when there are major changes in the short term — there is less need to worry about those shorter-term dips.
- You can’t measure what you don’t define
It’s difficult to score with a moving goal post. An investment strategy helps you benchmark and measure the effectiveness of your investments. Your benchmark should match your investment objective, which in turn, should match your investment strategy.
For example, say your investment strategy is to follow the market and invest in low-cost ETFs (exchange traded funds). Your benchmark would then be the S&P 500 Index, and you’d want to compare if your returns (after fees and other costs) match the index.
Your investment goals may change periodically, which is completely fine. Your investment strategy will also likely evolve as your goals and needs change (think about an aggressive, risk-seeking investor who reaches retirement and changes her focus to maintaining and protecting her assets through retirement). An investment strategy gives these shifts purpose, allowing you to invest with certainty and confidence.