Yulia received an unexpected bonus at work. Earlier that morning, she overheard a colleague mentioning that a large company was soon going to pay significant dividends, and it was urgent to buy its stocks. Yulia acted upon this information and made the purchase. However, the dividends were cancelled, the stock price dropped, and Yulia ended up in a loss. As a result, she decided never to engage in investments again. Let’s explain why acting impulsively on the stock market is not advisable, the importance of having a well-thought-out investment strategy, and how to choose one.
What is an investment strategy?
An investment strategy is a clear plan of action for your activities in the stock market. It should consider your investment goals and time horizon, the frequency of your transactions, and the factors you will rely on in your decision-making. It also involves determining the desired profit and the level of potential losses you are willing to accept.
Having a strategy will help you build a well-balanced investment portfolio, avoid impulsive decisions, and consequently reduce the likelihood of losses.
Investments always carry the risk of losing money. However, acting solely on instinct or based on the advice of acquaintances will only complicate the situation. That’s why it is crucial to adhere to a well-defined plan. It’s also important to periodically review and revise your strategy, especially when market conditions undergo significant changes.
Define your goal Answer a few questions for yourself: why do you want to invest, how much are you willing to invest, and when will you need the money?
Some people invest to save for a car, others aim to pay for their children’s education, while some plan to secure a comfortable retirement. You may have multiple investment goals, just like you can have multiple investment portfolios.
Set a time frame The time frame directly depends on your investment goal and when you will need the money. The following time frames exist for investment strategies:
- Long-term: You expect a return on your investments in three years or more.
- Medium-term: You are willing to invest for a period of one to three years.
- Short-term: You plan to withdraw money from the stock market in less than a year, or you may need the funds at any moment.
A long-term strategy allows you to choose various instruments with different risk levels and expected returns. For example, bonds or units of closed-end mutual funds with a maturity period of 10 years or more, which can offer particularly high yields.
Investing in precious metals can also be suitable for long-term investments. While their prices fluctuate significantly over one or two years, they generally outpace inflation and serve as a protective asset during periods of global financial instability.
When playing the long game, it’s especially important to diversify your investments among different companies, sectors, and types of securities to balance your portfolio and reduce risks.
Julia recently enrolled her daughter in first grade and started thinking that she may need money in 11 years to pay for her university education. Julia has a stable job, and she could allocate a portion of her income towards investments. If she decides to do so, a long-term strategy would be suitable for her.
A medium-term strategy offers a slightly smaller range of tools, but it is still quite diverse. You can choose assets that may fluctuate in price but generally generate profits within a 1-3 year horizon. For example, shares of reliable companies that regularly pay dividends, federal government bonds (OFZs), or secure corporate bonds, as well as units of exchange-traded funds (ETFs), open-end funds, or interval funds.
Ivan, Julia’s boss, plans to retire in three years. A medium-term strategy would be ideal for him to preserve his savings from inflation and secure additional income when he is no longer working.
With medium-term and long-term strategies, there is no need to constantly monitor stock quotes. It is sufficient to keep an eye on the market situation as a whole and periodically adjust the composition of your portfolio.
For long-term investments, you can earn additional income by using an individual investment account (IIA). If you do not withdraw money from the account within three years, you can benefit from tax deductions in addition to investment profits.
If you anticipate needing the money soon, a short-term strategy is appropriate. You should focus on liquid assets, which means assets that can be sold at any time. For example, freely traded stocks, bonds, units of open-end and exchange-traded funds (ETFs).
Artem has a good salary, no family yet, and he enjoys trading in the stock market with his spare money. The stock market is more like a hobby and entertainment for him. He doesn’t have long-term goals, but he uses his investments to earn money for vacations during winter and summer. He follows a short-term strategy.
The profitability of short-term investments depends heavily on the temporary fluctuations in the prices of your assets compared to long-term investments. If you aim for quick profits, you must be prepared for significant losses.
Estimate how much time you plan to spend on investments If you are not willing to constantly monitor financial markets, read news, and study company reports, a passive strategy is suitable for you. It is optimal for long-term and medium-term investments.
In this case, you don’t need to spend a lot of time analyzing the current situation. However, even with a passive approach, you cannot simply assemble a portfolio and forget about it – any investment requires monitoring. From time to time, you need to evaluate your assets and their risks and make adjustments if necessary, such as quarterly or semi-annually.
In addition to work, Julia spends a lot of time with her child. She is willing to become an investor, but she doesn’t have time to keep track of the stock market. Therefore, a passive strategy suits her.
Investors who are ready to react promptly to news and trade on a daily basis use an active strategy. They select instruments that can bring maximum returns and constantly monitor the best timing for buying and selling.
An active strategy allows for higher profits but also carries higher risks. The success of such a strategy depends on how accurately you assess the market situation. And keep in mind that active investors have to pay higher fees to brokers and exchanges for their operations compared to passive investors.
Artem has the time and willingness to understand the workings of the stock market. As an active investor, he studies financial summaries every morning and evening, tries not to miss any opportunity to make money, and executes numerous transactions.
When choosing an investment plan, take into account your own personality as well. Active strategies require a lot of energy and strong nerves. If you find it difficult to handle the loss of money and are prone to panic, it’s not advisable to start a risky game.
Decide on the level of risk you are willing to take Investment strategies are categorized into conservative, moderate, and high-risk based on the level of risk involved. Generally, the higher the potential profit from investments, the greater the likelihood of losing everything.
A conservative strategy is suitable for those who don’t want to put their capital at stake. The main goal for such investors is to safeguard their money from inflation. Conservative investors often choose government bonds, securities of large companies, and precious metals.
One should not expect high returns from such investments – typically, they will be around the central bank’s key rate, sometimes slightly higher. However, these investments can yield more than the interest on a bank deposit (especially if the person claims a tax deduction). And the probability of losses is not very high.
Ivan Nikolaevich is absolutely not willing to lose his savings. His conservative portfolio mainly consists of U.S. Treasury bonds, high-rated bonds, and a small portion of stocks from the most reliable companies. This portfolio composition allows him to increase his savings without being overly concerned about their preservation.
On the contrary, if you are chasing maximum profit and are prepared to easily accept the loss of your investments, an aggressive strategy is suitable for you.
Young people who have the time and ability to recover their savings in case of losses often choose this approach. Aggressive investors often invest in undervalued stocks of companies. Such securities can either experience rapid growth and bring significant profits or leave you with nothing.
Artem allocates 10% of his salary every month for investments. He enjoys taking risks, and his portfolio primarily consists of stocks of second-tier companies and derivative financial instruments. According to Artem and the experts he trusts, his securities have good growth potential. But in case of failure, he is fully prepared to part with his money.
However, the majority of investors prefer a moderate strategy. It involves selecting financial instruments with varying levels of risk. For example, one-third of the funds can be invested in the most reliable bonds
Having determined your investment strategy, here’s what you can do next:
- Gain a thorough understanding of how the stock market works and the specifics of different financial instruments. You can choose the optimal way to learn about investing by referring to the article “Where to Learn Investing.”
- If you feel confident and prepared to trade independently after your education, select a broker and start investing.
- If you find it challenging to navigate the stock market on your own, you can seek the assistance of an investment advisor. They can guide you in creating an initial portfolio and provide ongoing adjustments as needed.
- It’s important to note that investment advisors are held accountable for their recommendations, unlike many investment bloggers who may not always act in your best interest. When entering into an investment advisory agreement, make sure to work with professionals who have the necessary license from the appropriate regulatory authority, such as the Federal Reserve System (FRS) in the United States.
- If you prefer not to personally execute trades, you can opt for a discretionary portfolio manager who will handle the investments on your behalf. They may offer pre-defined standard investment strategies or develop a customized strategy based on your preferences. However, it’s still advisable to periodically monitor the performance of your portfolio.
- If you feel that your chosen strategy is not yielding satisfactory returns or is even resulting in losses, discuss with your portfolio manager the possibility of switching to a different standard strategy or adjusting your customized strategy accordingly. Regular communication with your manager is essential to ensure alignment with your investment goals.
Remember, investing involves risks, and it’s important to stay informed, review your portfolio periodically, and make adjustments when necessary.
