Wanna Make a Radical Shift? Be Careful Changing Investing Styles
You've probably seen dozens of ads explaining how you could achieve better returns by following some “proven” investment method. You may even be tempted to kick the tires on one or two, especially if you’re unhappy with your portfolio’s progress.
Let’s call this the “grass is always greener” syndrome. Just as you might itch to head to the dealership when your neighbor brings home a shiny new car and parks it next to your scratched-up model, you can feel pulled toward a new investment philosophy if your old one seems a bit rusty and beaten down.
There may be times when adopting a new trading method makes sense, but think things through carefully rather than making a spur-of-the-moment change. Sometimes, sticking to a single strategy can be more productive over the long haul.
Which Investment Approach to Utilize?
Let’s look at a few popular stock market investing methods. Perhaps you’ve adopted one.
- Value investing: Buying stocks at low valuations in hopes that they have room to grow.
- Growth investing: Focusing your portfolio on major sector growth areas like financials and info tech and rotating from one sector to another to take advantage of momentum.
- Dividend investing: Buying stocks that pay the highest dividends for a chance at better income.
- The hidden jewels: Buying beaten-up stocks of well-run companies that are struggling.
This isn’t a comprehensive list, but it does cover some of the major strategies. Some nuances — such as whether a stock is a "value stock" or a "hidden jewel" — could be in the eye of the beholder. Other variations exist, including choosing between actively managed mutual funds versus index funds and between large-caps and small-caps. Investors also can choose how much they want to focus on fixed income versus equities in their portfolios; one popular method is to start with the vast majority of funds in equities and gradually move toward fixed income over time. And as with any type of investing, all of these methods come with risk and none guarantees success.
Why Stick to the Same Strategy?
Once you're comfortable with a certain approach, patience becomes important.
"If you have a long-term investment strategy, you’ll want to have a long-term investing timeframe for that approach to work," said Michael Fairbourn, an Education Coach, TD Ameritrade. "You might be tempted to try to time the market for short-term gains — a common temptation — but this can often result in underperformance. It's important to remember the original reason why you selected a long-term approach and not let the potential for short-term profits alter your investing process."
Of course, markets can go down as well as up, and investors can always lose money even when sticking with one approach over the long term. There aren’t any guarantees in life or the stock market.
Even so, the market has tended to rise pretty regularly over the decades, and that means investors might want to consider sticking to their long-term strategies even in the down periods.
Why? Imagine a scenario where a growth investor goes through a typical market downturn, perhaps like the most recent one, when the S&P 500 Index (SPX) barely budged between mid-2015 and mid-2016 and growth sectors like financials and energy sagged. The growth investor who decided midway through that downturn that it was time to switch strategies and move into dividend-paying sectors like utilities and telecom would have missed out on the subsequent big gains in growth sectors—including energy and financials—that began in mid-2016 and eventually carried the market to new all-time highs. Of course, past performance doesn't guarantee future results.
“As an investor, you need to ask yourself if you’re being too reactive,” said Shawn Cruz, trader content specialist at TD Ameritrade. “If you went into value and it didn’t do well, do you give up after two months and go into growth? There’s an ebb and flow."
“You can change your stripes, but take a hard look at why,” Cruz continued. “What was your original reason for going into value stocks? Are you just being highly reactive, or have facts changed? What new factor or information do you have that makes you change your strategy?”
Some trends can play out over a couple of years, meaning patience is often paramount. An investor can’t just go into a value strategy and expect value stocks to always go up. Investors might want to consider riding out the downturns, knowing that historical trends show the “ebb and flow” Cruz referred to.
Thinking of Shifting Strategies?
Although a major change in strategy may not be the best idea, there are ways investors can attempt to manage their risk when their current strategy takes a ride downward. One way is through options. “Many sophisticated investors may use options as a tool to help them attempt to manage risk in their portfolio so they don’t have to do a total shift” in trading philosophy, Cruz said. Of course, options aren't suitable for all investors.
You can also respond to market trends while sticking to your philosophy by investing a small amount outside of your normal comfort zone. One example is Warren Buffett, whose long-term philosophy has always been to buy stocks of companies whose product and business model he understands. Back in the late 1990s, Buffett stuck to his guns and refused to change strategies even as internet stocks took off. Although his portfolio trailed the market for a few years, it ultimately pulled through when the internet bubble burst.
Recently, he started taking positions in a major info tech stock, in part because he saw the appeal of its products. He’s also become more aggressive in some of the higher-growth financial stocks. While he’s still mainly a value investor, he got his feet wet (just a little) in another type of trading philosophy.
"Over time, he has become more growth oriented," Fairbourn said, referring to Buffett. "He hasn’t necessarily drifted from his value investing roots, but he continues to adapt his approach."
All this could serve as a reminder that whatever the market does in coming months, you shouldn't let fear and emotions drive your investing decisions. Quickly reacting to changing circumstances might be a good idea if you're maneuvering your car around a sudden obstacle, but as a long-term investor it's important to think things through and not rush into sudden shifts.
The information is not intended to be investment advice or construed as a recommendation or endorsement of any particular investment or investment strategy, and is for illustrative purposes only. Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
All investing involves risk including the possible loss of principal.