What’s your investment style?
IT’S the New Year — time for resolutions and setting goals as we plan and organise our lives. No matter your current stage in life or where you stand on the social pyramid, financial affairs and money management always seem to top the resolution list come January 1st.
It is at this point many people decide to seek investment options. After all, what better way to improve your financial life than to figure out how to have your money working for you so that you don’t have to work your entire life! But before you run to a financial institution with cheque in hand (yet clueless to the fascinating world of investment), there is one question you need to ask yourself: What is my investing style?
If you are like most investors, you probably have no clue what your investment style is. Having a basic understanding of the various investment styles is one of the best ways to make some sense out of the vast options in the investment market available today. One way to break this down is to put the major investment styles into three categories: active vs passive management, growth vs value investing and small caps vs large cap companies. A quick look at these categories will help you to figure out what your investment style suits your personality.
Active vs passive
When figuring out your investment style you must first consider just how much you believe that financial experts can indeed generate above-average returns. Investors who desire to have professional financial managers select their holdings are interested in what is called active management.
Funds that are actively managed usually have a full-time staff of financial researchers and portfolio managers who constantly seek to gain larger returns for investors. This service comes at a cost to investors, so actively managed funds typically charge higher expenses than passively managed funds.
Other investors may question the ability of active managers to provide greater than normal returns and may opt for a more passive approach. Passively managed funds have one advantage: they do not require researchers hence fund expenses are often very low.
Growth or value investing
Further investment introspection leads to considering whether or not you may prefer to invest in fast-growing companies or underpriced industry leaders. Do not fear, analysts do this for you. They use financial metrics and judgement to determine which category a company belongs to.
Firms that have high earnings growth rates, high return on equity, high profit margins and low dividend yields are ideal for the growth style of investing. Companies with these characteristics are making lots of money and growing very quickly, while reinvesting most or all of their earnings to push more growth in the future.
Value-style investing is more focused on buying into a strong firm at a good price. Analysts therefore look for a low price to earnings ratio, low price to sales ratio and generally higher dividend yield. The value style is very concerned about the price at which investors buy.
Small cap or large cap companies
The third investing style relates to an investor’s preference to invest in either small or large companies. The size of a company is measured by its “market capitalisation” or “cap” for short. This is the number of shares of stock a company has outstanding, multiplied by the share price.
It is the belief of some investors that small cap companies should deliver better returns because they have more opportunities for growth and are more flexible. It is to be noted, however, that there is greater risk in the potential for greater returns in small cap companies.
This is because, among other factors, smaller firms have fewer resources and as such, less diversified business lines. Share prices can also vary more widely which results in large gains or large losses. An investor must be willing to take on this extra risk if they want to hold on to the potential for greater returns.
Risk-averse investors may opt to seek refuge in more dependable large cap stocks, popular options being GE, Microsoft and Exxon Mobil. Firms such as these, for example, have been around for ages and have become leaders in their respective industries.
They may have less room for growth being that they are already so large, but they are not likely to go out of business any time soon. Large cap investors can expect lower returns than with small caps, but on the upside, they can also expect less risk.
Before investing, think carefully about where you fall in each of these three investing styles. Having a clear understanding of your investing style places you in a better position to select investments you are most comfortable with, especially ones you will be holding for the long-term.
— Jodi-Kaye Allen isan advisor associate at Stocks & Securities Ltd.