A beginner’s guide to investment styles and which one works best for you
When you’re new to investing, it can be hard to know where to start. There’s no shortage of market commentators who want you to think they know exactly what you should do next in your portfolio.
But how can you sift through the noise to identify advice and investment opportunities that truly make sense for you? This is where having an investment style that you understand and makes sense for you can come in handy.
Here’s what to know about different investment styles and how to identify one that will work for you.
Understanding investment styles
An investment style describes a philosophy for how investments are chosen and may be based on factors such as risk, valuation, growth prospects or company size. It’s common to see mutual funds or ETFs based on different investment styles where the fund manager sticks to one philosophy over time.
Factors to consider when choosing your style
As you research different investment styles and philosophies, you’ll want to consider your investment goals, risk tolerance, temperament and general understanding of finance and investing. If you enjoy doing research on companies and have an understanding of accounting and finance, it may make sense for you to invest in individual stocks that you think can outperform an index fund, but less experienced investors may be better off with an entirely passive approach.
“Some people should not own stocks at all because they just get too upset with price fluctuations,” legendary investor Warren Buffett said in a 2018 interview. “If you’re going to do dumb things because a stock goes down, you shouldn’t own a stock at all.”
You may want to work with a financial advisor who can help you build a diversified portfolio that suits your needs. Bankrate’s financial advisor matching tool can help you find an advisor in your area.
Active vs. passive
One of the biggest differences in investment styles is between an active and passive approach. An active investment strategy involves choosing investments that you believe will outperform the broader market, while a passive strategy involves choosing funds that track broad market indexes such as the S&P 500.
An active strategy may involve buying individual stocks that you think will do well, or investing in actively managed funds that attempt to beat the market through their research and portfolio management.
Everyone wants to do better than the market, but passive strategies often end up outperforming active ones over the long term. It turns out that it’s extremely difficult to beat the market over an extended time frame, and active funds come with the added burden of high costs. If you decide to take an active approach, be aware that you’re attempting to do something that most investors fail at over time.
Growth vs. value
The stock market often gets sliced up based on different factors and the distinction between growth and value is one of the oldest. Unsurprisingly, growth stocks tend to have above-average growth rates of revenue and earnings, while value stocks tend to have lower growth rates, but trade at lower multiples of earnings and assets.
In reality, the line between growth and value isn’t so easy to draw. Growth is an important part of determining a company’s value, and it’s certainly possible for high-growth companies to trade for less than they’re worth. Conversely, just because a company trades for a low multiple of current earnings doesn’t mean that it’s selling for less than it’s worth.
“All intelligent investing is value investing,” Buffett’s late business partner Charlie Munger once said. “You have to acquire more than you really pay for, and that’s a value judgment. But you can look for more than you’re paying for in a lot of different ways.”
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Risk-based investment styles
Conservative
A conservative investment style will tend to hold fixed-income investments and may include money-market funds, certificates of deposit, Treasury bonds or high-quality corporate bonds. This investment style might make sense for someone with a very low risk tolerance, someone who has short-term financial goals or someone looking to generate income from their portfolio.
Moderate
An investor with a moderate risk appetite may hold a balance of stocks and bonds in their portfolio. Their stock allocation will tend to focus on large-cap companies with strong profitability and may include dividend stocks. These stocks can still decline in a downturn, but may suffer less than their smaller, less profitable rivals.
Aggressive
An aggressive investment style will likely focus exclusively on stocks and will likely tilt toward the growth end of the spectrum. These companies may be small caps that are not yet profitable, but growing quickly. An aggressive investor may also look to emerging markets for higher growth even though these geographies come with higher risks. Any bond allocation might include high-yield bonds of companies with questionable credit quality.
Bottom line
Investment styles provide a framework for how investments are selected for a portfolio. The right style for you will depend on your financial goals, risk tolerance, temperament and other factors. Selecting an investment style that works for you may help you sift through the noise and focus on the best opportunities that meet your needs.
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