We’re living in the age of personalization. From computers to disease-fighting drugs to blue jeans, we demand tailored solutions. One size definitely does NOT fit all.
Personalization is super important in investing (though you probably wouldn’t know that just by watching talking heads spew generalized investment advice on TV). Every investor brings a unique situation to the investing table that requires solutions that fit — solutions that reflect the individual investor’s time constraints, personal goals, relationship with risk, family structure, and future prospects.
Identifying the best investing strategy begins with answering tough, personal questions.
To get the right strategy, investors need to be able to answer questions like:
- Why are you investing? To what end?
- How do you plan to save?
- How do your plan to use those savings?
- What’s your current level of debt?
- How much risk are your comfortable assuming to reach your goals?
- What if you miss your target? Is there a Plan B?
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A recent college graduate or newlywed is likely to have different investment characteristics from a seasoned investor or new investor looking to retire soon.
So, what type of investing strategies can investors adapt to their personal styles?
The Diversified Portfolio
You know the old adage, “don’t put all of your eggs in one basket”?
Well, that sums up the concept behind the diversified portfolio.
Diversification is a risk management technique that achieves something somewhat magical: by combining a variety of different investments together in a portfolio, investors can achieve higher returns on the portfolio with lower risk than any of the individual constituents of the portfolio. Ka-ching.
Listen, markets are finicky. Sometimes one type of investment performs particularly well while others suffer. Diversification plays into this dynamic — by combining a variety of different securities in a portfolio, an investor allows positive performance of one holding to counter-balance any negative drag of another.
You can both diversify at the asset class level (like with stocks, bonds, cash, and commodities) and by spreading each asset class investment over different securities within the class, the way mutual funds do. You can even diversify across geographies.
Diversification requires more than buying stock in several companies. If you buy shares of McDonald’s (MCD) and Jack in the Box (JACK), changes in the fast food industry, such as healthy diet trends in the U.S., would equally affect both companies. However, purchasing shares in different industries, such as General Mills (food) and Chevron (oil/gas), creates greater balance.
Add commodities and bonds to the portfolio, and you are diversifying at more than one level.
To achieve diversification at the asset class level, investors can buy:
- Real estate
For diversification across industries, portfolios can include holdings from:
- Numerous others
Diversification can utilize holdings of different size companies:
- Micro Cap
- Small Cap
- Mid Cap
- Large Cap
Consider diversifying across geographies, as well. Economies grow at different speeds and having exposure to more than just the U.S., spreads the risk around (and diversifies currencies).
The Income/Dividend Portfolio
Companies that pay dividends distribute a portion of their profits to shareholders. Investors in dividend-paying stocks receive a monthly, quarterly, annual or semi-annual dividend. This income is passive — it comes just by holding the shares (you can also make money by selling the shares for a profit).
Dividends are a part of a long-term, wealth-building plan, but can also serve as a source of cash flow. Income/Dividend strategies focus on recession-resistant companies with strong histories of paying higher than average dividends. There are several companies with decades-long paying streaks, such as Johnson & Johnson (JNJ), 3M (MMM) or Proctor and Gamble (PG). Investors can use this cash flow for special purchases or everyday living expenses; however, you can also grow your portfolio by using the dividends to buy additional shares of stock through a reinvestment plan.
For investors focused primarily on generating income, consider preferred stocks (really a hybrid of a stock and a bond). They typically pay higher dividends than regular, common stocks and aren’t intended to provide any growth. There are exchanged traded funds (ETFs) — single securities that own baskets of these preferred stocks — that also provide some diversification. Just beware: in uncertain times, companies can stop paying dividends on preferred stocks.
When using dividends to expand your portfolio, there are several advantages of Dividend Reinvestment Plans (DVPs), sometimes referred to as Stock Purchase Plans or Optional Cash Purchase Plans:
- Investors can purchase additional shares for little or no fee
- Companies may offer the stock at a discount off market price of up to ten percent
- Stock holders may be able invest as little as $10 to $50 per month through an automatic electronic bank draft
If you have a high risk tolerance and are looking for short-term aggressive growth, a portfolio of stocks with a high projected price to earnings (P/E) ratio may produce.
The P/E is a ratio that compares price to earnings. Sometimes called a price orearnings multiple, this valuation metric indicates how much investors are willing to pay for a stock for every dollar in earnings it produces. High growth companies typically have high P/E ratios as investors expect the stock to increase in value as earnings rise.
The P/E ratio is not a crystal ball. This strategy includes volatile stock prices and low dividends and is called a “momentum strategy” because it looks for strong stocks that are getting stronger. It is certainly not for the faint of heart or for those who would rather have an passive relationship with their investments.
However, as in all of investing, there is risk, even if an investor has an appropriate and personalized investing strategy. But as many investment managers would quip, “No risk, no reward.”