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Investment Strategies II – Active Investing

To continue with yesterday’s article on passive investing, lets go over the basics of active investing.

Active Investing

Active investing is where the investor is more involved with the security/stock picking and when to buy and sell.  This style of investing requires substantially more ongoing research and discipline (emotional and logical).  Although you can simply pick a mutual fund to do the active investing for you, not all active mutual fund will perform well.  In fact, as mentioned before, most active mutual funds will not even beat the index (after fees).

There are many types of active investing styles.  The ones listed below do not account for “trading” strategies, but more along the lines of longer term buy and hold.

Value Investing

Value investing is where the investor purchases companies with strong balance sheets/fundamentals that are selling for under market value for some reason or another.  As a result, the investor purchases the stock at the perceived discount and holds for the long term. This is the style that Warren Buffett uses and has had renowned success.  Note though that very few investors have been able to achieve the same success as Mr. Buffett.

I’ve written a piece on an easy to reproduce stock screen that attempts to replicate Benjamin Graham’s (Warren Buffets mentor) strategy for value investing.

If you aren’t interested in picking your own stocks due to the amount of required research, you may elect to go with an active mutual fund to do the value picking for you.  Note though that for the most part, indexing will beat active management most of the time.

Growth Investing

With this style of investing, smaller market capitalization (small cap) stocks with strong balance sheets and high growth potential are purchased in the hopes that they will experience capital growth over time.  This type of investing is much more volatile than investing in blue chips, but it also has the potential for much greater capital gain.

When I look into individual small cap stocks, I research their “story”, future prospects, current financial condition along with current valuation.  Even after extensive research, there are no sure bets, which is why I only allocate a small portion of my portfolio to small caps.

If you’re not interested in actively picking small caps, but would like to have exposure to the sector, you can look into small cap ETFs like, the Russell 2000 index ETF, IWM or even the Canadian small cap ETF, XCS.

Dividend Growth Investing

Dividend growth investing is a popular long term strategy which focuses on buying strong dividend paying blue chips which have a history of increasing their dividends.  The goal is to generate a growing income stream (and capital gain) from your portfolio that is tax efficient.

This is the strategy that I use for my leveraged portfolio where I pick my own dividend paying equities.  As the dividend achievers list is based on this strategy, you can simply purchase an ETF, like CDZ (CAD) or VIG (USD), that serves the same purpose.

Final Thoughts

I’ve only scratched the surface of active investing with the strategies above.  If you are interested in actively investing a portion of your portfolio, I would suggest that you learn how to read balance sheets along with key financial ratios.  One book that does a great job of explaining how to properly pick stocks, which I highly recommend, is One Up on Wall Street by Peter Lynch.

I hope you enjoyed the series on passive and active investing.  Feel free to leave your comments on the investment strategy that you use.

If you would like to read more articles like this, you can sign up for my free newsletter service below (we will not spam you).

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FrugalTrader About the author: FrugalTrader is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 15 comments… add one }

  • Sampson May 12, 2009, 12:38 pm

    Hey FT, in addition to the three strategies (which I’d categorize under fundamental analysis) – technical analysis is one strategy some use to ‘actively’ select investments. Others might call it Voodoo though ;)

  • Nurseb911 May 12, 2009, 12:40 pm

    I think value investing, growth investing and dividends can all be combined easily into a single strategy and I combine them together in my own activities. The pure investors of each discipline will argue against that claim, but an investor is completely capable of integrating the best elements of each into their own independent strategy for investing success.

    Enjoying this series so far MDJ!

  • Mark Wolfinger May 12, 2009, 1:32 pm

    Everybody has his/her own method for choosing investments, whether it’s mutual funds, ETFs, individual stocks etc.

    But what is missing is any mention of the risk of being invested in the stock market while unhedged. I just don’t get it. Didn’t you learn a lesson during 2008? Why risk going through that again?

    By sacrificing a portion of profit potential (and that sacrifice occurs ONLY when markets surge), the average investor can protect the value of his/her assets. Conservative option strategies reduce the risk of investing, yet PF bloggers ignore this aspect of investing (as do all financial planners and most stockbrokers).

    Sure your discussion of passive vs. active investing is important – but once that decision has been made, those investments should be protected with options.

    http://blog.mdwoptions.com/options_for_rookies/2009/04/trade-options-now-is-the-time.html

  • Patrick May 12, 2009, 1:59 pm

    One mistake: value investors are not looking for stocks “selling for under market value”. They’re looking for stocks selling for less than their fair value — a much more nebulous and subjective concept.

  • FrugalTrader FrugalTrader May 12, 2009, 2:31 pm

    Mark, what if an investor holds many individual securities? How would you suggest that they use options to protect their portfolio? Perhaps an equity collar on each position?

  • WhereDoesAllMyMoneyGo.com May 12, 2009, 6:46 pm

    @FT – an imperfect hedge, with cash-settled options, like index options, instead of ETF options or single stock options would do the trick.

  • cannon_fodder May 12, 2009, 7:08 pm

    If I value the growth of dividends, what strategy do I use? ;-)

  • J.Chu | SuccessRevolution.com May 13, 2009, 2:58 am

    Hi FT,

    I used to active at stock trading before the global crisis killing all my portfolio down.
    Now, just wait for it to recover slowly.

    For long term investment, we need to see the stock which be sold under it exactly value, and for play short-term, traders prefer to play the active stocks, and of course it is very high-risk.

    For choosing the devidend-stock, mostly it makes correction on market after the devidend payment.

    Investing in stock is good, but we must keep learning, and well educated about it, otherwise it’s like gambling.

  • Neil May 13, 2009, 10:07 am

    The dividend stratgey is a good/more reliable option because you are targetting companies that are successful now rather than potentially successful in the future. These companies don’t need to be blue chips, just ones that generate healthy profits and dividends.

    Of course the potential rewards are probably lower as well.

  • Rajeev Kumar Singh May 13, 2009, 2:30 pm

    Very well written article explaing the various investment startegies.The best strategy in my opinion is the one that suits your investment horizon and goal. For someone like Warren Buffett, value investing is the way to go. He loves picking up stocks which have inherent value and are expected to do well consistently over a long period of time. His investment horizon is usually in decades and not in years.

  • Ms Save Money May 13, 2009, 6:48 pm

    I think it is hard to be “Active” on investing in stocks since it’s more for people who do a lot of short selling. Most common people are passive stock traders.

    Thanks for the suggestion – one up on wall street. :) I’ll check it out sometime.

  • Penny Pincher May 14, 2009, 1:09 pm

    posted in the wrong place…

  • Canadian Finance May 14, 2009, 5:46 pm

    My goals for active investing are to pick Canadian, dividend paying stocks within a Smith Manouvre.

    The second form of somewhat-active investing for me will be to pick the top 4 REITs and hold the within a TFSA.

  • Dividend Growth Investor May 15, 2009, 4:37 am

    Hmm I always considered dividend growth investing a “passive” strategy. You select 30+ stocks with solid fundamentals, wide moat business, rising earnings, cashflow and then rising dividends, and you wait and reinvest your dividends.
    One think I wouldn’t do is buy dividend growth ETFs or Mutual Funds, whose portfolios are pretty slow to adjust for dividend cutters or eliminators.

    Oh and I also consider myself a value investor, since I do not like to overpay for companies. I also enjoy a modest “growth” in my portfolio so that my companies can sell more products, make more money and ensure a stable rising dividend payment.

  • Canadian Finance May 17, 2009, 2:06 pm

    DGI, I too would lead towards dividend growth investing as more of a passive form of investing.

    I think FT means it’s active in the way you analyze the stocks and are taking responsibility for your choices, as opposed to putting your money on an index fund.

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