In this writing, we’re looking at three best investment strategies. These strategies are best describing the ideas to maintain your portfolio in order to tackle the vagaries of the financial markets’ things like risk and volatility. So, make sure you read all three for better understanding of these approaches.
Number One: Fixed Cost Averaging
The first of these three investment strategies is fixed cost averaging this is also called a dollar cost averaging. You can think of it as a kind of drip-feed way of investing. So, in this approach, we are investing a fixed sterling of dollar or euro amount into our investment or investments of choice and financial markets. As the stocks or financial instruments prices can go up as well as down. We don’t know what the future holds. There is always an element of uncertainty in investing but by investing a regular fixed amount it means that when prices go down, we’re going to be buying more and when prices go up, we’ll be buying less. This can help to smooth out the effects of volatility. So, let’s look at this in a bit more detail.
If you wanted to invest a lump sum of $6000 in a stock market. If you invest the lump sum of the amount in a stock then you’re on the risk of buying at a peak. So, there’s some kind of timing risk and this is what we could do to try and mitigate that risk is to instead break up our investment into regular small investments. Let’s look at some sample numbers for that here we have a table of sample figures to illustrate regularly investing a fixed amount. Let’s say our hypothetical investor wants to invest a thousand dollars per month in a stock ABC.
Sr. # | Month | Price ($) | No. of Shares | Cost ($) | Holdings | Investment Value ($) |
1 | June | 20 | 50 | 1000 | 50 | 1000 |
2 | July | 22 | 46 | 1012 | 96 | 2112 |
3 | August | 18 | 55 | 990 | 142 | 2556 |
4 | September | 16 | 62 | 992 | 197 | 3152 |
5 | October | 17 | 59 | 1003 | 259 | 4403 |
6 | November | 21 | 48 | 1008 | 318 | 6678 |
| Average Cost | 19.00 |
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Instead of purchasing the stocks at lump sum price, the investor decided to purchase stocks in a span of six months with monthly purchase of stocks worth $1000. In the first month the stock was trading at 20 dollar per share so he purchased 50 shares that cost him $1000. In the next month the stock price was increased to $22 per share. With this price he can manage to purchase only 46 shares instead of 50. In the next month the stock price become $18 per share. With this price he can purchase 55 shares by remaining within the limit of $1000 per month. Through this way, he can purchase more share when the price is down and can purchase less shares when the price is up. So, at the end of the sixth month, the stock was trading at $21 and he managed to purchase the 318 shares of that organization with an average price of $19 and the overall investment value is on positive side. If he purchased all the stocks at the lump sum price of $20 at the start then his profit would be much less than this. Because of fixed cost averaging, the average price reduced to $19 per share that has removed the timing risk from the market. Every investor cannot time the market exactly and there is always a chance that you will buy the right stock but at the wrong time which result in losing the trade. So, if you are a beginner investor and cannot time the market well then fixed cost averaging will be the best technique to enter the market. It is a nice disciplined and orderly approach that spreads out the timing risk rather investing one lump sum all in one go.
Number Two: Diversification
The basic idea of best investment strategies is the diversification which means don’t put all of your eggs in a single basket. Diversification is one of the widely adopted investment strategies by many investors. In diversification, you’ve got a nice wide cross-section of investments in your Portfolio. This will reduce the chance of all underperforming stock to affect your capital. It will increase the chance that when some underperform stocks in the portfolio will take up the slack by over performing stocks. In this kind of investment strategies, you can diversify by having different asset classes in your portfolio and you can diversify within those asset classes. Let’s take a look at that in a bit more detail.
When we’re diversifying a portfolio there’s more than one way, we can do it. One way is via asset classes putting our investment capital into different types of assets such as cash or cash equivalents fixed income such as bonds and equities. We are basically talking about the stock market. Historically, equities have given the best returns over the long term but they are more volatile. It depends on your risk-taking capacity to how much invest in which stock depending upon their volatility. We can also diversify within assets classes. In the below table, you can see a two-step diversification process. In the first step, the investor made a diversification with different asset classes like cash, fixed income, and equities. In the second step, the investor did the diversification with the same asset class like equity one, equity two and equity three. In the second step, the diversification can be even deeper by purchasing the equities on the basis of different market sector like banking, technology etc.
Step one. Diversification for Asset Classes |
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1. Cash | Step two. Diversification within asset class |
2. Fixed Income | 1. Bonds |
2. Saving Accounts | |
3. Equities | 1. Equity one |
2. Equity two | |
3. Equity three |
Number Three: Rebalancing
Rebalancing is to regularly rebalance the idea after a fixed period of time, for example, every six months or every year you’re going to tweak your portfolio. So, after this fixed period of time you would look at the makeup of your portfolio and adjust as necessary to maintain your desired asset allocation. Let’s look at this in a bit more detail. So, here are some sample figures to illustrate an aspect of rebalancing.
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Rebalancing |
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Target |
Start ($) |
End ($) |
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Cash |
5% |
5,000 |
5,200 |
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Fixed Income |
60% |
60,000 |
65,000 |
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Equities |
35% |
35,000 |
45,000 |
Let’s say that we have a hypothetical investor who has decided their target for how they want their investment portfolio to be divided up is 5% in cash 60% in fixed income and 35% in equities. So, just to make these numbers quite easy, let’s say that they have 100,000 dollars for the year. So, this would work out as a five thousand dollars in cash 60,000 dollars in fixed income and $35,000 in equities and they check at the end of the period. Let’s say it’s the end of the year and the cash has increased to $5,200, fixed income products have increased to 65 thousand dollars and the equities holding is now at worth forty-five thousand dollars. So, the percentage makeup of the portfolio has changed because of the performance of these different assets. Now, these new percentage before rebalancing of asset class is as per below table.
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5,200 |
4.51% |
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65,000 |
56.42% |
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45,000 |
39.06% |
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Total = 115,200 |
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After rebalancing at the end of the year and to achieve the initial percentage targets, the new portfolio will be look like as per below table.
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Rebalancing at year end |
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Target |
Capital ($) |
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Cash |
5% |
5,760 |
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Fixed Income |
60% |
69,120 |
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Equities |
35% |
40,320 |
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Total |
100 |
115,200 |
Here is the rebalancing aspect. At the end of the year, they might decide that they want to keep it in line with these targets which means they’re going to tweak things a little bit. Sell some of these equities because they may be feeling a little bit overexposed now and just move that the funds over into fixed income and cash just to bring these the percentage holdings back in line with these targets. The investor may decide to change the percentage of these asset classes depending upon their performance and changing risk taking capacity.
In the similar way the rebalancing can be done within an asset class. For example, the hypothetical investor decided to put 35% of its equity in banking sector and 65% in the technology sector. At the end of the year the percentage may be change and he has to rebalance it by selling the stocks of one sector and by purchasing the stocks of other sector to maintain the pre-decided percentage target.
Now, decide on the basis of your personality and suitability that which kind of investment strategies most suited to you and go with that approach. You can also apply more than one approaches at a single time as well. Good Luck!
