An introduction to investing- part two

Strategy Begins With Planning

This is the second installment of An Introduction to Investing by Troy, the first of which can be found here.

In this second installment, I’m going to be discussing the various investment strategies, and the pros and cons of each. Remember – there is no “right” or “wrong” strategy, only one that works (or doesn’t work) for you. Each investor is different and what works for me might not work for you. How can you determine which strategy fits you best? Test them out one at a time!

The long, long-term investor

What the long, long-term investor does is rather simply – just keep buying on the dips and hold his/her portfolio of stocks until he’s (or she’s) 60 years old. This is known as buy-and-hold. Every time the market falls, “It’s time to buy more. After all, I’m getting a discount”. Every time the paycheck comes in, set aside some cash to buy more stocks.

Pros: The advantage of buy-and-hold does not lie in investment returns. There’s no way you can get 15% a year (on average) just by buying and doing nothing. Rather, the advantage in buy-and-hold lies in the fact that you’re doing nothing that’s difficult.

Many of us have kids and families to take care of, not to mention the job that consumes 8 hours of our lives, 5 days a week. When you’re this busy, the only option you have left is to buy-and-hold, because doing that takes the least amount of time (compared to the other investment strategies). You literally do not have to think – just buy when the market falls.

Cons: The biggest question is, can you afford to buy-and-hold for 40 years? Let’s assume that you make $70,000 a year, and your investment strategy is to buy and hold until you retire. A recession comes along, and you keep buying on the dips because hey, that’s a part of the strategy! The market tanks by 50%, and soon enough, your company leaves you unemployed in the midst of a massive lay-off.

At the bottom of the market crash, you’re forced to sell off most of your investment portfolio because you have to make ends meet at home. Soon enough, the market rebounds, but you’ve just sold at the bottom. This is a story that happens to far too many buy-and-holders. So ask yourself, can you really afford to buy-and-hold?

The long-term investor

The long term investor typically buys or sells a security once every couple of years. In other words, he’s betting on the fundamental direction of the economy and the stock market. What the fundamental investor does is relatively harder than what the buy-and-hold investor does.

The fundamental investor follows the economic data (briefing.com) and closes scrutinizes how the economy is doing. If the economy is doing well, then the fundamental investor will keep buying. If the economy is doing poorly, then he will sell. Unlike the buy-and-hold investor, the fundamental investor does not have a bullish bias.

*(As a side note, I’d like to mention that the problem with a lot of economic data is that it seriously lags real-time. For example, May’s data may be released in June, thereby making the data less useful. There are a few indicators that don’t lag as much, however I cannot reveal that data as it is proprietary information).

The fundamental investor must also realize that the stock market lags the economy. This is critical for making the right investment decisions – just because the economy has started to turn south doesn’t mean the market will fall. For example, the U.S. economy peaked in 2006. Yet, the stock market peaked in 2007, a FULL YEAR after the economic peak.

The more active investor (or trader)

The trader will do one of two things: contrarian trading or trend following.

The trader, unlike the fundamental investor, will use price data instead of economic data. The trader solely bases his trading decisions on the price.

The contrarian trader will be a contrarian (makes sense, doesn’t it?) If the price falls really fast, he’ll take the opposite stance and buy the security.

The trend follower, on the other hand, says that he cannot predict when the market will turn. Rather, he’ll hop onto the bandwagon as soon as the trend has materialized because his belief is that the trend will continue.

What I do

So what do I do? I have multiple investment accounts, each running a different strategy (although the one strategy I do not use is buy-and-hold, because that’s more for mom-and-pop investors who do not have enough time on their hands).

In my biggest account, I use not one but three different strategies. My other blog’s motto is “Think Like a Fundamental, Trade like a Technical”. In other words, my big picture is like the fundamental investor – I’m always looking at how the economy is doing. HOWEVER, under that big picture outlook I use both contrarian and trend following techniques.

When I first enter or exit a position, I’ll use contrarian signals because if everyone’s selling, then I want to be buying. BUT, if my contrarian investment model misses the market (e.g. does not create a buy signal when I actually should be buying), my trend following model will kick in so that I can get back into the market as soon as possible.

Editor: What investment strategies do you use?

Join Troy next week with part three in his introduction to investing series for Canadian Budget Binder fans.

Contribution By: This is the second installment in a series of guest posts from Troy. His blog, The Financial Economist, provides insight into the financial market and thoughts on the economy. Check out his latest post on Characteristics for Bear Market Bottoms. Cheers, and see y’all in the third installment!

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