Equity investments outperform all other financial assets over the long term. So, why is it that some people fare poorly when investing in stocks, even in years when the stock market is producing stellar returns?
To suggest that these people have simply invested in the wrong companies is unfortunately only half the answer. For those who have not been successful with equities, the problem can usually be traced to their investment style.
Instead of using a systematic investment approach, they often treat the stock market like a lottery or gambling casino. Such investors may buy a company’s stock based on a tip from a friend or relative. They rarely read fundamental research. Indeed, in the worst case, they may not even know what business their investment is in. Obviously, this haphazard approach is not the best way to realize meaningful capital gains over the long term.
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In a past column I stressed that accumulating and preserving wealth requires a sound investment strategy.
To invest with confidence, you need to understand what makes sense to you when buying stocks.
What’s a fair price? What’s value? What strategy best fits your nature?
Let’s take a quick tour of three strategies you’ve probably heard about: growth, value and price momentum. Determining which one best suits you may help you make the best choice next time you talk to your investment adviser about a stock or a mutual fund.
Growth investors
While value investors count assets, growth investors study how fast a company is growing and don’t care how much they pay for growth. They care about earnings momentum.
They analyze a company’s quarterly growth looking for those that are higher than last year’s and in the early stages of a trend. They try to beat the analysts’ estimates and outthink value investors.
The danger with growth is that investors sometimes get caught up in the belief that it will last forever and get into dangerous territory when earnings start slowing down.
The fall can be steep.
You need to be disciplined enough not to pay too much for a stock, or quick enough to get out at the first signs of trouble.
Value investors
Value investors try to find stocks that are selling at less than they’re worth. Warren Buffett is probably the best-known value investor.
They dig through a company’s assets looking for value that’s not captured in its official measure of assets.
In recent times, value investors have had a hard time sticking to their beliefs when the “technology” trend captured the headlines and investment dollars. That’s because value managers tend to buy stocks when no one else wants them and sell them when everyone else is enthusiastic.
Value investing takes time, patience and lots of digging because value stocks can languish for months or years. However, value investing does reward patience because research indicates that this strategy slightly outperforms growth style over time.
Price momentum investors
Price momentum investors care neither about earnings nor assets.
They study the movement of a stock’s price over time to discover patterns that will predict the future. They look for stocks rising faster or about to rise faster than the market, sometimes through technical analysis.
This strategy doesn’t work well in trendless markets when the best thing is to sit it out.
If this seems complicated, that’s why there are investment advisers. Their role is to help you find your own investment style, to take advantage of the markets and the best investment for those markets.
Understanding these styles can help you develop a more successful portfolio in the long run.
When you meet with your investment adviser, remember that current stock selections and mutual fund recommendations are linked with one or more of these styles.
An investment adviser should set realistic long-term goals for both the desired rate of return and the amount of risk acceptable in achieving this return.
This approach also involves choosing an appropriate asset allocation model between stocks, bonds and other investments, and ensuring that an adequate level of diversification is maintained.
Ian Morrison is an investment adviser with Wood Gundy Private Client Investments in Calgary and is licensed to sell insurance products. His views do not necessarily reflect those of CIBC World Markets Inc. or The Western Producer. Morrison can be reached at 800-332-1407 or by e-mail at ian.morrison@cibc.ca.
