When you start investing on your own, the investing world may seem vast and overwhelming. However, with time-tested strategies, you can simplify the process. A solid investment strategy can lead to good returns over time and allows you to focus on other parts of the investing process or even spend more time on activities you enjoy.
Here are five popular investment strategies for beginners, along with their advantages and risks.
Top investment strategies for beginners
A sound investment strategy minimizes your risks while optimizing potential returns. However, remember that investing in market-based securities like stocks and bonds can result in short-term losses. A good investment strategy takes time and should not be viewed as a “get rich quick” scheme. Start investing with realistic expectations of what you can and cannot achieve.
1. Buy and hold
A buy-and-hold strategy is a classic approach with a proven track record. As the name suggests, you buy an investment and hold it indefinitely, ideally for at least 3 to 5 years.
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Advantages: This strategy focuses on long-term thinking, avoiding the pitfalls of active trading that often reduce returns. Your success depends on how the underlying business performs over time, which can lead to significant gains. If you commit to never selling, you avoid capital gains taxes, which can erode returns. This long-term approach means you don’t have to constantly monitor the market, allowing you to focus on other pursuits.
Risks: The key challenge is resisting the temptation to sell during market downturns. You must endure the market’s steep declines, which can exceed 50 percent, with individual stocks potentially dropping even more. This requires significant discipline and patience.
2. Buy the index
This strategy involves selecting an attractive stock index and investing in an index fund based on it. Popular indexes include the Standard & Poor’s 500 and the Nasdaq Composite, which contain many top stocks, providing a well-diversified collection of investments. Instead of trying to outperform the market, you own the market through the fund and receive its returns.
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Advantages: Buying an index is a straightforward approach that can yield excellent results, especially when combined with a buy-and-hold mentality. Your return will be the weighted average of the index’s assets. With a diversified portfolio, you’ll face lower risk compared to owning just a few stocks. Additionally, it requires less work as you don’t need to analyze individual stocks, allowing you more time for other activities while your money grows.
Risks: While investing in stocks carries inherent risks, a diversified portfolio reduces this risk. To achieve the market’s long-term returns—about 10 percent annually for the S&P 500—you must endure tough times without selling. Owning a collection of stocks means you get their average return, not the peak returns of the best-performing stocks. However, most investors, including professionals, find it challenging to consistently beat the indexes over time.
3. Index and a few
The “index and a few” strategy combines the index fund approach with a few individual stock positions. For instance, you might allocate 94 percent of your money to index funds and 3 percent each to Apple and Amazon. This method allows beginners to maintain a lower-risk index strategy while adding some exposure to individual stocks they find appealing.
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Advantages: This strategy blends the benefits of the index fund approach—lower risk, minimal effort, good potential returns—with the opportunity for more ambitious investors to add individual positions. These small positions help beginners learn to analyze and invest in stocks without risking too much capital if those investments don’t perform well.
Risks: As long as individual positions remain a small portion of the portfolio, the risks are similar to those of buying the index. You’ll still tend to achieve the market’s average return unless you own several high-performing or underperforming individual stocks. If you plan to invest in individual stocks, dedicate time to understanding how to analyze them. Without proper analysis, your portfolio could suffer.
4. Income investing
Income investing involves owning investments that generate cash payouts, typically through dividend stocks and bonds. Part of your return comes from cash payouts, which you can use as you wish or reinvest into more stocks and bonds. Owning income stocks allows you to benefit from both capital gains and cash income.
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Advantages: You can implement an income investing strategy using index funds or income-focused funds, avoiding the need to pick individual stocks and bonds. Income investments usually fluctuate less than other investments and provide regular cash payouts. High-quality dividend stocks often increase their payouts over time, enhancing your income without additional effort.
Risks: Despite being lower risk than stocks in general, income stocks can still decline in value. Individual stocks may also cut dividends, potentially to zero, resulting in no payout and a capital loss. Many bonds offer low payouts, making them unattractive due to limited or no capital appreciation, and their returns may not outpace inflation, reducing purchasing power. Additionally, income from bonds and dividend stocks in a regular brokerage account is taxable, so holding these assets in a retirement account like an IRA may be beneficial.
5. Dollar-cost averaging
Dollar-cost averaging involves regularly adding money to your investments at fixed intervals. For example, you might invest $500 monthly or $125 weekly, regardless of market conditions. By consistently purchasing investments, you spread out your buying points over time.
Advantages: This strategy avoids the risk of “timing the market,” or investing all your money at once at a potentially high price. Dollar-cost averaging ensures an average purchase price over time, preventing you from buying at peak prices. It also promotes regular investing discipline, leading to a larger portfolio over time due to consistent contributions.
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Risks: While dollar-cost averaging helps avoid investing a lump sum at the wrong time, it also means you won’t invest all your money at the optimal time, potentially resulting in lower overall returns.
How to get started investing
Investing can seem overwhelming, but new investors can simplify the process with a few basic steps and leave the complex details to the professionals.
Here are several resources for new investors:
These links provide educational content and research on stocks and ETFs, along with detailed instructions on placing trades and maximizing broker capabilities. Most major online brokers don’t require a minimum account size, so you can get started quickly, even today, if you just want to explore.
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Summary
Investing can be one of your best decisions, but getting started can be challenging. Simplify the process by choosing a popular investment strategy that works for you and sticking with it. As you become more knowledgeable about investing, you can expand your strategies and explore different types of investments.
