CommSec - 3.2 Investment strategies and types

3.2 Investment strategies and types

What this topic covers:

✓ What type of investor are you?
✓ Investing for regular income or capital growth
✓ Investing vs. trading
✓ Managed funds: passive vs. active trading
✓ Fundamental analysis vs. technical analysis

Understanding what type of investor you want to be

Sometimes you need to consider things on a macro level before you delve into the micro. Here is a case in point. When considering what type of investor you want to be, you must first make sure that your investment strategy is aligned to your investment goals. So, take a minute to remind yourself of the goals you set.

Then consider:

Do you want to take a “hands-on” DIY approach?

Do you prefer to “set and forget?”

Will you seek financial advice from an accredited adviser – either one-off or regular?

Let's look at this in more detail.

Hands-on vs. set and forget

Teaching yourself about investing – through CommSec Learn, for example – can give you the understanding and confidence to do your own analysis on investments you’re interested in. This approach allows you to make your own investment decisions, and it means you won’t be spending any of your hard-earned savings paying someone else for their advice. But if you choose this route, you should always consider your investment goals and risk tolerance, and make sure you fully understand the risks and returns of any investment before you commit to it. In addition, you should think about the time and effort you’ll need to take this “hands-on” approach.

If you have a more “hands-off” approach to investing, then making regular investments through CommSec Pocket could be right for you. With Pocket, the fund managers do all the hard work for you. All you have to decide is which of the ten themed ETF you want to invest in, how much you want to invest, and how often. And that’s it; the app does the rest.

One-off or regular advice?

A financial adviser can be a useful part of your extended advice team. Just like an accountant or lawyer, think of a financial adviser as a professional providing impartial advice. That could involve paying for advice in a one-off session to talk through specific strategies around say super or insurance. Or it may comprise of regular, ongoing advice – which you also pay for – to help you determine goals and create an investment strategy. Optionally, the financial adviser can also provide you with access to investments, however, the cost of advice won’t cover fees and commissions.

Another way a financial adviser can be useful is if you have – or plan to create – a large portfolio of different assets. They can help you manage it.

Investing for regular income or capital growth

In topic 2: Your investment goals, we touched on the two types of “return” that shares can deliver: they can provide the potential for income through dividends, and the potential for profit through capital growth. Let’s quickly examine this in a little more detail.

Income stocks

These are companies that reliably pay a percentage of their earnings as dividends to shareholders. They are often in mature industries with relatively consistent sources of revenue – but moderate to slow growth. For example, utility companies with customers who can be expected to use similar amounts of energy, year after year. These companies look to keep their shareholders satisfied with regular dividends. You can also invest in Exchange Traded Funds (ETFs) that give you exposure to a range of companies with a track record of consistently paying dividends.

Who is an income strategy best suited to?

Someone looking to supplement or replace an income – especially for people close to retirement.

Growth stocks

These are companies focused on expansion. Whilst these types of companies can offer the potential for share price improvement, their share prices can be more volatile as their earnings are less predictable. For example, they may miss growth expectations in terms of revenue target or customers acquired.

Who is a growth strategy best suited to?

A growth strategy might suit you if you have a long-term investment outlook.

Investing vs. trading

"The stock market is designed to transfer money from the active to the patient. Don't be impatient when it comes to your money..."

- Waren Buffett (One of the most famous investors and chairman and CEO of Berkshire Hathaway)

Long-term investing

Ideally, companies are looking to secure long-term investors as this provides them with the capital support to grow and put their business strategies into place. This style of investing – buying shares in a company that you believe will grow in the long term whilst weathering the short-term ups and downs – may suit those looking to build future wealth. It’s also known as ‘buy and hold’ investing.

Fundamentally, long-term investing is based on having a view of a company’s “intrinsic value” over a period of time. So, while it may go through short-term market fluctuations – driven by any number of factors – its fundamental value will prove resilient over the long term.

Short-term trading

Traders are more focused on making a quick gain. They buy shares ahead of an anticipated rise in the price so they can take a quick profit and move on to the next opportunity. The idea is to generate frequent, consistent financial gains.

A trader is unlikely to concern themselves with the long term credentials of a company, but they’ll care about whether its share price will rise in the short term. Trading is often based on technical analysis but also speculation, generated by rumour or headlines – anything that supports the idea of short-term money making.

Although it may appear to contradict the theory of investing, trading actually plays an important role in today’s stock market. Individual traders and institutional investors trade at a high volume and frequency, so they increase the level of liquidity in the market, making it easier for all investors to buy and sell when they want to.

Risk analysis – investing vs. trading

Investing:

Shares could fall in value (both short and long term)

Companies don’t perform as well as expected, resulting in smaller or even no dividends

Trading:

Shares could fall in value

Trading costs can quickly add up

Selling shares less than a year after buying could result in higher capital gains tax*, eating into returns

*We're a stock broker, not a tax aficionado, so you should consult your taxation adviser for advice about your situation.

Managed funds active vs. passive trading

Managed funds are another investment option. They come in two main styles: actively managed and passively managed.

Actively managed investment funds

In an actively managed fund, the fund managers make regular investment decisions on your behalf, such as which shares to buy and when to sell them. The aim is to make higher returns than the market or a specific benchmark index.

Passively managed investment funds

Passive funds track a specific market or index in an attempt to match its returns. For example, the fund manager might buy all of the shares in the ASX 200 index, in an attempt to emulate its performance. Not surprisingly, this style of fund, which is also known as a tracker fund, is cheaper to invest in than actively managed funds. A good example of this type of fund is Exchange Traded Funds (ETFs) which are becoming increasingly popular.

Managed funds risk analysis – the pros and cons

Pros:

You get access to a range of assets through a single investment

The risk is spread, because if some parts of the fund don’t perform well, others may pick up the slack

Funds can buy component parts of a portfolio for much lower costs than you can (think of a big supermarket that buys in bulk compared to your local milk bar)

There are many fund options available, giving you access to assets or industries that may ordinarily be more difficult to invest in – like foreign currency or commercial property

There’s less effort on your part, as the fund managers make all the investment decisions

Cons:

The value of the fund can fall as well as rise

There is no guarantee that an actively managed fund will outperform the market

Typically have higher fees than passive funds (because more management is required)

Fundamental analysis vs. technical analysis

In many ways, this is where share investing gets really fascinating – when we get into the nitty gritty of a business.

Fundamental analysis

Fundamental analysis involves a deep dive into the company, looking at areas like:

Strengths and weaknesses

Business credentials

Financial performance and factors that affect earnings

Dividends and future growth prospects

Competitor activity and market sector performance

It can help you determine whether shares are currently trading at an attractive price relative to the company’s fundamental value.

Fundamental analysis has two distinct areas:

Story – what the company does, how it makes money, what the future may hold

Numbers – the company’s annual report, cash flow, debt, earnings and profit

With the numbers, it’s always useful to start with the company’s annual or half yearly reports. You can download these from the CommSec website if you have an account (log in and head to Quotes & Research, then look under Announcements.) Or you can often download them straight from the company’s website. These reports not only include a wealth of financial details, but also provide important insights into the company’s strategy and which direction it’s headed in. In later topics, we’ll cover some more of the key ways to conduct fundamental analysis, including earnings per share, P/E ratios (price to earning), dividend yields, earnings and profit.

Technical analysis

Often referred to as charting, technical analysis involves studying past movements in a company’s share price to help predict how it might move in the future. The idea is to use share price charts to identify trends. (It’s worth noting that these trends can also be examined across industries and sectors and even entire indices, such as the ASX200.)

Here’s an example.

This company’s shares have traded no lower than $7 over the past 5 years

In that time, they’ve traded no higher than $15

The shares have regularly fluctuated between the two ends of the scale

In this example, knowing this information suggests to an investor that they should look to buy shares when they are close to $7 and sell when they’re approaching $15.

Some investors like to use a mix of the two approaches. That is, use fundamental analysis to identify companies to invest in and technical analysis to work out when to buy and sell. It’s yet another investing strategy.

Which suits your investing style? Here’s a quick summary.

Next topic: 3.3 Consistency and compounding

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3.1 The value of a strategy	🕑 2m
3.2 Investment strategies and types	🕑 7m
3.3 Consistency and compounding	🕑 3m
3.4 Diversification	🕑 3m
3.5 Quick quiz	4 q's

3.1 The value of a strategy	🕑 2m
3.2 Investment strategies and types	🕑 7m
3.3 Consistency and compounding	🕑 3m
3.4 Diversification	🕑 3m
3.5 Quick quiz	4 q's