When Francis Gingras Roy works with his clients, one of his priorities is to help them understand "behavioural investing" and the emotional drives of an investor. In this adapted excerpt from his book, The Investment Revolution, he outlines the eight most popular strategies.
When I work with my clients, one of the financial terminologies I help them to understand is “behavioural investing.” In short, this is a catch-all term used to describe the psychological forces, that is, the emotional drives of the investor, that can have an overwhelming sway on investors’ decisions.
For example, consider the following. You are presented with two investment choices: (1) an investment with a fifty-fifty chance of a quick profit and a fifty-fifty chance of a large loss and (2) an investment with a small but long-term profit that also has a lower prob- ability of loss. Which one would you choose?
Most investors would choose investment #2, yet, mathematically, the potential for profit is greater for investment #1. What drives the investor’s decision when choosing either investment? The overriding factor is emotion. And understanding the effects of emotion is key to understanding behavioural investing.
Whether we realize it or not, we are all driven by our emotions, and when it comes to investing, emotions are a driving force more than we care to admit. For example, someone who is detail oriented and a logical thinker—and considers themselves to be emotionally even keeled—would tend to be a more conservative investor, and investment #2 would fit their mindset. Conversely, a person who is outgoing, enthusiastic, and risk tolerant would be inclined to go with investment #1.
For this reason, I educate my clients on the power that emotions can have when the markets are volatile.
To help counter – or contain - these emotions, the wisest strategies for your investment planning are best determined through conversations with your investment advisor. However, before doing so, it is important clients understand the most common investment strategies. Here are the eight of the most popular investment strategies I explain to investors.
Buy and hold
Buy and hold is the most commonly used strategy for long-term goals. In simple terms, an asset is bought and held until financial goals are reached and the investor’s financial plan shifts. For example, if a stock or fund is purchased and held for, say, ten years, once the investor moves from their career into retirement, money made could then be used to fund travel, purchase a condo, or whatever needs the investor has at that time. How well a buy-and-hold portfolio performs is dependent upon the assets that are held.
A key to this type of strategy is that individual investors can be their own worst enemies and too often sell their investments at the wrong time. A buy-and-hold strategy eliminates that problem. Buy-and-hold assets are companies that have been or are likely to be around for a long time. These are companies with strong brands that you recognize in your daily life. Keep your positions small so that any stock that devalues will not greatly affect your portfolio and those that do well boost your portfolio.
Growth investing
A growth investment strategy gives you the opportunity to invest in the fastest growing sectors and industries capable of producing high annual returns. Researching sectors and companies presents the opportunity to learn about who is innovating and creating the future. However, while growth stocks typically have the highest valuations in the market, investing should be done with caution. Companies need to develop a track record and live up to expectations to justify their valuations. If not, the stock price will correct, quickly and dramatically. Research must win over market opinion.
Value investing
Value investing focuses on companies with solid earning that trade at or below their fair market value. Consider that this type of investing has produced the most consistent long-term returns over the last one hundred years, and the most well-known investor in the world, Warren Buffett, has made much of his fortune this way. It is important for investors’ financial statements to determine the true value of a company in order to identify the high-quality stocks that are discounted.
Small cap investing
Small cap investing focuses on companies valued between $300 million and $2 billion. It is easier for these companies to double their value compared with mid- or large-market cap companies, but they can be overlooked by investors and there are two main advantages to focusing on smaller companies. First, it is easier for a small company to grow its profits. Doubling revenue from a base level of $100 million is a lot easier than to trade it at a discount. However, they are less likely to be liquid—they can be harder to sell—and their share price can be more volatile.
Dividend investing
Dividend investing, also known as income investing or yield investing, focuses on generating a steady stream of income. High dividends can be found with very profitable stocks, but they also have slow rates of growth. Wise investors will reinvest their dividends as a way to grow their portfolio without using their own money. Companies that pay dividends tend to be quite profitable, making dividend investing a good strategy during times of recession.
Dollar cost averaging
With this strategy, set amounts are invested at regular and predetermined intervals. Dollar cost averaging can be used in any market condition, eliminating the guesswork out of trying to time a market. When the market is trending down, shares are purchased at a lower price, which balances out higher-priced shares purchased when the market is trending up. One of the great advantages of this strategy is that lower-priced shares produce greater capital gains when markets are positive. The key to this strategy is to maintain regular purchases.
Diversification
As the name of this strategy states, diversification is about purchasing a variety of investments rather than just one or two assets. Diversification helps to diminish emotional responses to market volatility by providing protection. Rarely do all industries move in unison, and a diversified portfolio takes into account different industries and sectors and can even include real estate and private equity.
Contrarian investing
A contrarian is someone who goes against prevailing market sentiments. Contrarian investing means investing in assets that go against what others are doing. When the stock market is trending down, contrarian investors are buying, and when markets are trending up, these investors are selling. In other words, they go against the herd mentality. For example, much of Warren Buffett’s approach to investing is contrarian. He looks for stocks that are out of favor and are closely examined for their fundamentals and value. As a contrarian, he is quoted as famously saying, “I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.”
More details on Francis Gingras Roy’s book, The Investment Revolution, can be found here.
