Investment Strategies II – Active Investing
To continue with yesterday’s article on passive investing, lets go over the basics of 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 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.
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.
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.