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So, what is the best investment strategy for YOU in 2020?
The best way for you to invest your money very much depends on your age, your financial goals and level of risk tolerance.
For example, your investment strategy in your 20s will be very different from that in your 50s.
When you are in your 50s and nearing your retirement, you might want to adopt a more conservative investment strategy and look for investment opportunities that are considerably safe and are also able to generate stable monthly retirement income for you.
But, when you are in your 20s, you still have a lot of time ahead of you and you don’t really have a lot of financial responsibility yet ( e.g. providing for your children and making mortgage payments)
So, you could afford to take more risks and might want to adopt a more aggressive investment strategy that has a lot of upside potential.
In this post, I am going to show what are the different types of investment strategies and EXACTlY how to choose the best investment strategy for yourself.
But, before we start, I want to share with you something really important – the right mindset for investing.
Get Your Mindset Right Before Investing Your First Dollar
When it comes to investing, there is always risk.
What is risk?
It means that there is a real possibility that you will lose your money ( part of all or even all of it).
So, before you use your hard earned money to invest, think about why you made the choice to save and invest.
For early retirement?
A bigger house?
Kid’s college tuition?
Be mindful of your why and treat your money with more care.
Why do I want to say this?
Because too many people only look at the upside and ignore the downside risk.
That’s NOT the mindset you want to adopt when you start investing.
Just image what you would do if you are asked to bet your entire savings on a fair coin toss.
It’s a double or nothing.
Would you do it?
Of course, you wouldn’t.
Then, would you be willing to risk 30% of your savings to make an equivalent gain?
Because losing a substantial amount of money could affect your standard of living. On the other hand, a comparable gain would not improve your life by as much.
In other words, you might feel the risk is not justified by the return.
So, why would you do it differently when it comes to investing?
Risk of Ruin
Below is the table of the risk of ruin.
You can see that the more you lose, the harder it gets to recover your loss.
In fact, when you lose 50% of your capital, you will have to make a 100% gain to make back your lost capital.
Warren Buffett famously said,
“Rule No. 1: Never lose money. Rule No. 2: Don’t forget rule No.1”
So, don’t get lost in pursuit of high return in the short term when you should focus on consistent returns for the long term.
And take advantage of the 8th wonder in the world – power of compounding.
With compounding, even moderate returns can exponentially grow your money over time.
So, what is compounding?
Compounding refers to continuously reinvesting your returns back into your investments so that your previous returns can also generate its own earnings.
For example, if you invest $1,000 at the beginning of the year, you will get $1,100 at the end of year at an annual return of 10%.
So, instead of taking out the additional $100 that you have earned, you put it back into your investment and let it generate returns for you.
When it comes to compounding, the earlier you start, the sooner you can take advantage of the power of compounding to grow your wealth exponentially over the long term.
Now, you might ask, ” Do I really need to start early? Is it really worth it? ”
Let’s look at the example below.
If you start investing at the age of 21 with an annual investment of $2,000 for the next 20 years, your total investment of $24,000 will be about $500,000 by the age of 67, assuming an 8% return compounded monthly.
But if you start investing much later at the age of 47, the same total investment of $24,000 will only be about $60,000 by the age of 67, assuming an 8% return compounded monthly.
Just by delaying to invest by 26 years, you lose out by almost $450,000 in returns for the same amount of investment.
So, when it comes to investing, here are two golden rules that you need to follow:
- Start as early as possible even if it’s just a small amount of money
- Don’t lose money (i.e. take calculated risks)
How To Choose The Best Investment Strategy
If you are new to investing, what should be the most suitable investing strategy for you? How do you decide which one is the best for your situation?
To answer these questions, you need to know these two things first:
- What are the investment strategies available?
- What is your investing style?
Now, let’s talk about investment strategies first.
There are two broad types of investment strategies:
- Passive investing strategy
- Active investing strategy
Passive investing generally refers to a buy-and-hold strategy for long-term investment horizons, with minimal trading in the market.
This is most suitable for people who prefer a hands-off approach to investing.
Active investing generally refers to an investment strategy that involves ongoing buying and selling activity by the investors.
This is most suitable for people who prefer a more hands-on approach to investing.
In other words, it’s best for people who want to be actively involved and constantly monitor their investments and markets to look for profitable investment opportunities.
Now, which one is more suitable for you? Passive or active investing?
Passive investing is probably better for you if :
- You don’t have a lot of investing knowledge and experience
- You are not very passionate about investing or learning more about investing
- You have no time to choose and manage your investments
However, if you are into investing and don’t mind spending a lot of time to choose and manage your own investments, then active investing is a better option for you.
Best Investment Strategies
Passive Investing Strategy
The most common example of passive investing strategy is investing in an investment fund such as exchange-traded-funds (i.e. ETFs) or mutual funds.
So, which one is better? Or should you invest in both?
The ONLY investment fund that you should put your money in is exchange-traded-funds.
First, what is an exchange-traded-fund?
An exchange-traded fund (ETF) is an investment fund that holds assets such as stocks, bonds or commodities.
It trades on an exchange, just like a stock. So, you can buy and sell ETFs the same way as stocks.
There are three broad types of ETFs:
- Stock ETFs
- Bonds ETFs
- Commodities ETFs
When you invest in a stock ETF, you are not buying just one stock but many different stocks.
That’s good because if you invest in just one single stock, you could lose all your money if that company goes bankrup.
But that will NEVER happen with a stock ETF because it’s extrememly unlikely that a group of companies can go bankrupt at the same time.
So, which stock ETFs are good investments?
There are stock ETFs that only invests in a specific industry like healthcare or financials.
However, I don’t recommend it if you are just starting to invest.
Here is what I DO recommend – Stock Market Index fund ( e.g. S&P 500 index fund)
An S&P 500 index fund invests in the 500 stocks that comprise the S&P 500 index, in market cap-weighted proportions.
So, when you invest in S&P 500 index fund, it’s almost the same as investing in all the 500 stocks at the same time.
That is very diversified.
Diversification is good because your risk will be reduced.
Also, index fund represent the health of the country’s economy.
A country’s economy can go through periods of growth and recession, but it will always grow over time in the long term.
What that means is that index fund will always go up in the long term.
Besides stock market index ETFs, investment-grade bond ETFs are also a good investment choice.
It’s safer and less volatile compared to index ETFs, so it’s good for investors who are more risk averse or those who want a more balanced portfolio.
So far, I have said a lot of good things about ETFs.
What about mutual funds?
Should you invest in mutual funds too?
The short answer is STAY AWAY FROM mutual funds.
Mutual funds are generally professionally managed by fund managers.
And research has shows that more than 90% fund managers CANNOT beat the stock market index return.
In other words, you are better off putting your money in a passively managed index ETFs which closely tracks the stock market index return.
What’s more is that mutual funds charge higher fees (typically 1 to 1.5%)
Compared to mutual funds, ETFs have much cheaper fees which are less than 0.5%.
That’s only about 1% difference in fees, BUT this small 1% can significantly reduce your returns over years.
Assuming that you invest $100,000 with an investment fund for 20 years with a 4% annual return, let’s see how much a small percentage increase in annual fees can reduce your portfolio value.
0.5% annual fees reduce your portfolio valube by $10,000 compared to a portfolio with a 0.25% annual fee.
Let’s put this in perspective.
$10,000 is 10% of your total investment value.
So, a 0.25% increase in annual fees cost you a 10% decrease in your investment portfolio.
1% annual fees reduce your portfolio value by nearly $30,000, compared to a portfolio with only 0.25% annual fees.
$30,000 is 30% of your total investment value.
Let’s put this in perspective,too
So, a 0.75% increase in annual fees cost you a 30% decrease in your investment portfolio.
My advice for you is that STAY AWAY from mutual funds and ONLY invest in stock market index ETFs with very low all-in annual fees (i.e. expense ratios)
So, how and where do you buy market index ETFs?
One of the most reputable ETF providers is Vanguard.
Once you open your investment account with any stock brokerage or investment apps, you should be able to find ETFs in the investment products they offer.
Just like I said earlier, you can start investing with just a couple of hundred dollars a month.
Active Investing Strategy
If you prefer a more hands-on approach to investing, then an active investing strategy is more suitable for you.
Here are some of the best active investment strategies that you can choose from.
Value investing is an investment strategy made famous by Warren Buffet, one of the greatest investors of all times.
So, what is value investing strategy?
Value investing is all about buying good businesses at a discount to their intrinsic value.
In other words, you will be looking for undervalued stocks to buy.
Warren Buffett has used value investing strategy to help him make billions of dollars over the span of 60 years.
So, this investment strategy is proven to work.
Often, we have the misconception that if we want high return, we have to be willing to take high risk.
This is NOT true.
Value investing is one of the few strategies that can offer you low risk and high return.
Why is it low risk and high return?
Because value investors invest with margin of safety.
Margin Of Safety = Intrinsic Value – Market Price
The difference between the intrinsic value and the market price is called margin of safety.
What it means is that investors will only buy the stock when the market price is significantly below its intrinsic value.
A high margin of safety offers more protection and higher returns.
Dividend Stock Investing
Dividend stock investing strategy is about finding companies that will pay consistent and predictable dividends in the future.
Companies that have a long history of paying consistent dividends are generally well-established companies.
Examples of such companies are utilities companies and REITS.
The best part about this strategy is that it offers investors both income and capital appreciation.