Investment strategy: definition and types


In order to work in the financial markets, you need to have a clear plan of action. The effectiveness of investments depends on the correctly selected strategy. What is an investment strategy, and what are the criteria of choosing the right one, we will figure it out further.

Concept and role of investment strategy

An investment strategy is an investor’s plan how to work in the financial markets. It is usually developed individually and depends on the goals and personal characteristics of the investor. The main criteria that must be followed when choosing an investment strategy are:

  • Financial goal. It determines what result the investor plans to achieve in the investment process. It is desirable that the goal is specific and measurable.
  • Investment horizon. This is the period for which the investor plans to achieve his or her financial goals.
  • The size of the start-up capital. It determines what instruments and in what quantity an investor can afford to include in his or her investment portfolio.
  • Risk appetite. This is the maximum acceptable level of risk that the investor is ready for. Some investors are very sensitive to any fluctuations in asset values. Even the slightest drawdown in the investment portfolio can knock them out of their rut. Others, on the other hand, are willing to take risks for the sake of high returns. The more an investor is risk averse, the more aggressive the investment strategy can be.
  • Frequency and amount of contributions. Ideally, investments should be regular. Experts recommend allocating a portion of the income for investments. This does not have to be a large amount. It is necessary to choose the most comfortable amount of contributions.

All of these characteristics must be taken into account when developing a strategy. Having an investment strategy plays an important role in the investment process. Ideally, this is a well-built algorithm of actions that are aimed at achieving a financial goal. An investment strategy helps an investor to make informed and timely decisions about buying or selling assets. If the investor has a clear strategy and adheres to it, then this allows him or her to refrain from impulsive deals and decisions that do not correspond to the ultimate goal.

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Classification of investment strategies

According to the investment period, the following types of strategies are distinguished:

  • Long term. As a rule, this strategy is unlimited in time or has a long investment horizon. Specialists derine long-term strategies as those that involve investments in the future from 7 to 10 years. Such strategies are based on the idea that the price of any asset in the long term will still rise, even if in the process their value will periodically fall.
  •  Medium term. Such a strategy implies investments for a certain period. There is no exact time frame here. Investors refer to this category of strategies for a period of 3 – 5 years. Very often the investment period depends on specific assets. For example, by purchasing dividend shares in an investment portfolio, an investor plans to receive passive income from them for 5 years. However, after a few years, the profitability of the shares falls, and the investor is forced to get rid of them and buy new ones.
  • Short term. This type of strategy resembles speculation. The main way to make money is short-term transactions. Investments in IPOs with the aim of subsequent resale of shares after the start of trading are also classified as short-term strategies.

According to the degree of investor involvement in the investment portfolio management process, the following strategies can be distinguished:

  • Active. This strategy assumes constant working in the stock market. The investor is constantly analyzing the market, trying to identify its trends. On the basis of fundamental and technical analysis, the investor determines the assets that are more effective for investment and quickly acquires them. And, on the contrary, in the process of analyzing the effectiveness of his or her investment portfolio, an active investor gets rid of assets that do not generate income.
  • Passive. This strategy does not require the investor to constantly manage the portfolio. Portfolio rebalancing is carried out only as a last resort when portfolio returns have fallen sharply. Or when an investor decides to change his or her strategy. In other cases, assets are acquired with the expectation of sale only at the end of the investment period.
  • Active-passive. This is a combination of the previous two approaches. With such a strategy, part of the assets remains unchanged throughout the investment period; the investor constantly makes transactions with other assets. Typically, the ratio of passive to active assets is 70% to 30%.
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Depending on who manages the investment portfolio, strategies can be divided into:

  • Self-sufficient. It involves managing the investment portfolio on your own.
  • Fiduciary management. The investor’s assets are managed by trustees. Such services are provided by management or investment companies, brokers or financial marketplaces, for example, Asset Capital Business or CMC Markets.

Depending on the ratio of risk and return, the following types of strategies can be distinguished:

  • Conservative. This strategy assumes a low level of risk and, accordingly, profitability. Therefore, an investor who adheres to a conservative strategy should form his or her investment portfolio from the most stable and reliable instruments. For example, deposits, federal bonds, gold, and other low-risk instruments.
  • Aggressive (speculative). This strategy is suitable for investors who are not afraid to risk their capital for high returns. Basically, the investment portfolio consists of high-yield assets with a high level of risk. These include options, futures, second and third tier stocks, which can bring an investor both large income and losses.
  • Balanced. This is a combination of the first two options. A moderate level of risk and return is ensured by asset diversification. The ratio of high-risk and conservative instruments is approximately equal. The presence of instruments with a high level of risk is offset by defensive assets.

Types of investment strategies

There are a lot of types and directions of investment strategies. Let’s consider the most popular typology.

  • Dividend strategy involves buying shares of large issuers who pay dividends to their holders. Such a strategy is created not so much for a more profitable resale of shares when they rise in price, but mostly for generating passive income through dividends. The main difficulty of such a strategy is the choice of issuers with a profitable dividend policy. To do this, it is necessary to conduct a thorough analysis of the market and familiarize yourself with the terms of payments to the shareholders of a large number of companies. It is important to choose those ones whose dividend policy does not depend on the value of the shares.
  • Index strategy is an investment in stocks that are part of stock exchange indexes (ETF). In other words, this is not an acquisition of individual assets, but a set of shares in companies in a particular industry. The advantage of this approach is the initial diversification of tools by professionals. Index strategy is a type of passive investing. The investor does not need to constantly monitor the dynamics of the market, they will do it for him.
  • Value investing is an investment in undervalued companies whose shares have the potential to grow many times over in value. Finding companies with high growth potential requires fundamental analysis skills. First of all, the investor must be able to competently analyze the financial statements and identify the points of growth of the company. Value investing is a complex and risky strategy. It requires experience and certain skills from the investor.
  • Buy and hold” is one of Warren Buffett’s strategies. He advises buying long-term stocks and ditching them only when it is most profitable. This is a long-term strategy, the essence of which is to buy stocks with the expectation of their final growth in value in the long term.
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