Investing on your own may seem like a daunting and scary thing.
Here are five popular investment strategies for beginners, along with some of their advantages and risks. Luckily you can make things much simpler by using tested strategies. Having a solid investment strategy can lead to good returns in the long-run while allowing you to focus on other aspects of investing or in your career.
Top investment strategies for beginners
The point of utilizing an investment strategy is to optimize for returns while simultaneously reducing risk. But with any strategy it’s vital to remember that you can lose money in the short run if you’re investing in market-based products be it stocks or bonds. A good investment strategy is one that works, but often it takes time to work – years – and investing is not a “get rich quick” scheme. So it’s important to begin investing with realistic expectations of what you can and can’t achieve.
1. Buy and hold
A buy-and-hold strategy is a classic that’s proven itself over and over. With this strategy you do exactly what the name suggests: you buy an investment and then hold it indefinitely. Ideally, you’ll never sell the investment, but you should look to own it for at least 3 to 5 years. Usually for example, when one wants to buy and hold a stock for years they look at fundamentals and the leaders of the company to see if this investment is a promising one.
Advantages: The buy-and-hold strategy focuses you on the long term and thinking like an owner, so you avoid the active trading that hurts the returns of most investors. Your success depends on how the business performs over time. And this is how you can ultimately find the stock market’s biggest winners and earn hundreds of times your original investment.
The beauty of this approach is that if you commit to never selling, then you don’t ever have to think about it again. It is certainly less stress full than trading constantly or looking at charts all day. Also if you never sell, you’ll avoid capital gains taxes, which can be a return killer. This strategy means that you’re not always focused on the market – unlike traders – so you can spend time doing things you love instead of being chained to watching the market all day.
Risks: To succeed with this strategy, you’ll need to avoid the temptation to sell when the market gets rough. You’ll have to endure the market’s sometimes-steep falls, and a 50 percent drop is possible, with individual stocks potentially falling even more. That’s easier said than done. Knowing when is a buying opportunity is also a tough part, although if your holding for years this may not be your biggest worry.
2. Buy the index
This strategy is all about finding an attractive stock index or ETF and then buying an index fund based on it. Two popular indexes are the Standard & Poor’s 500 and the Nasdaq Composite. They each have many of the market’s top stocks, giving you a well-diversified collection of investments, even if it’s the only investment you own. Rather than trying to beat the market, you simply own the market through the fund and get its returns. This way you are diversified without having to do too much research on multiple different companies. You would be suppressed at how many fund managers don’t beat the market.
Advantages: Buying an index is a simple approach that can yield great results, especially when you pair it with a buy-and-hold mentality. Your return will be the weighted average of the index’s assets. And with a diversified portfolio, you’ll have lower risk than owning just a few stocks. As stated, you won’t have to analyze individual stocks to invest in, so it requires much less work, meaning you have time to spend on other fun things while your money works for you.
Risks: Investing in stocks is risky already, but owning a diversified portfolio of stocks is considered a safer way to do it. But if you want to achieve the market’s long-term returns – an average 10 percent annually for the S&P 500 – you’ll need to hold on through the tough times and not sell. This can get tough during a downturn especially if one needs access to that capital. Also because you’re buying a collection of stocks, you’ll get their average return, not the return of the hottest stocks.
3. Index and a few
The “index and a few” strategy is a way to use the index fund strategy and then add a few small positions to the portfolio. For example, you might have 94 percent of your money in index funds and 3 percent in each of Apple and Amazon. This is a good way for beginners to keep to a mostly lower-risk index strategy but add a little exposure to individual stocks that they like.
Advantages: This strategy takes the best of the index fund strategy – lower risk, less work, good potential returns – and lets the more ambitious investors add a few positions on companies that they’re confident in. The individual positions can help beginners get their feet wet on analyzing and investing in stocks, while not costing too much if these investments don’t work out well.
Risks: As long as the individual positions remain a relatively small portion of the portfolio, the risks here are mostly the same as buying the index. You’ll still most likely end up getting average market returns depending on your risk tolerance and what percentage of individual stocks are in your portfolio. Of course, if you’re planning on taking positions in individual stocks, you’ll want to put the time and effort into understanding how to analyze them before you invest. Otherwise, your portfolio could take a hit. There are many ways to do this, learning about the company and checking out their fundamentals is a good first step.
4. Income investing
Income investing is owning investments that produce cash flow, often dividend stocks and bonds. Part of your return comes in the form of hard cash, which you can use for anything you want, or you can keep reinvesting the payouts for more stocks and bonds. If you own income stocks, you could also still enjoy the benefits of capital gains in addition to the cash income.
Advantages: You can easily implement an income investing strategy using index funds, ETFs, or other income-focused funds, so you don’t have to pick individual stocks and bonds here. Income investments tend to fluctuate less than other kinds of investments, and you have the safety of a regular cash payout from your investments. Plus, high-quality dividend stocks tend to increase their payouts over time, raising how much you get paid with no extra work on your part.
Risks: While lower risk than stocks generally, income stocks are still stocks, so they can fall, too. And if you’re investing in individual stocks, they can cut their dividends, even to zero, leaving you with no payout and a capital loss, as well. You will need to do research on which stocks are dividend paying stocks that are typically stable. Most growth stocks won’t offer this since they prefer to keep reinvest their profits. Because of this you could miss out on stocks that have huge upside. When it comes to bonds the low payouts on them make them unattractive, especially since you’re not likely to enjoy much or any capital appreciation on them. So returns from bonds may not even beat inflation, leaving you with reduced purchasing power.
5. Dollar-cost averaging
Dollar-cost averaging is the practice of adding money into your investments at regular intervals. For example, you may determine that you can invest $500 a month. So each month you put $500 to work, you do this regardless of what the market is doing. Or maybe you add $125 each week instead. However regularly you purchase an investment, you’re spreading out your buy points.
Advantages: By spreading out your buy points, you’re avoiding the risk of “timing the market,” meaning the risk of dumping all your money in at once. After all “time in the market” is more important than “timing the market”. Dollar-cost averaging means you’ll get an average purchase price over time, ensuring that you’re not buying too high. Dollar-cost averaging is also good for helping to establish a regular investing discipline. Over time you’re likely to wind up with a larger portfolio, if only because you were disciplined in your approach.
Risks: While dollar-cost averaging helps you avoid buying too high, it also prevents you from buying at the lowest price, too. So you’re unlikely to end up with the highest returns on your investment.
How to get started investing
Investing is a wide and complicated world, and new investors have a lot to learn to get up to speed. There is no one way or correct way of getting started, all that matters is that you do. Investing can be scary but with the right education and work it can be very rewarding. The good news is that beginners can make investing relatively simple with a few basic steps while they leave all the complex stuff to the pros.
Investing can be one of the best decisions you can make for yourself, but getting started can be tough. You can simplify the process by picking a popular investment strategy or two that can work for you and then stick with it. When you become more fully versed in investing, then you can expand your strategies and the types of investments you can make.