The saying, “the only constant in life is change” certainly holds true in the investing arena. Markets fluctuate, inflation rises or falls, and mergers and exciting new products change the competitive landscape. To navigate these and other challenges, you’ll need some solid investing strategies. We’ve chosen to highlight 7: asset allocation, diversification, rebalancing and reallocating, dollar-cost averaging, value investing, growth investing and passive vs. active investing.
1. Asset Allocation
Asset allocation means spreading your investment dollars among different types of investments (e.g., stocks, bonds and cash equivalents like money market funds). You decide what percentage of your money you’ll invest in each investment type. These 3 major factors will impact your decision:
- Your investment goals: Before you start, you’ll need to decide what you want to accomplish. Do you have more than one goal, and are they short- or long-term goals? Short-term goals can range from a few months to a few years (e.g., vacation, down payment). Long-term goals can span several years or even decades (e.g., child’s education, retirement).
- Your age or time horizon: When will you need the money? For example, people who are within a few years of retirement would likely want to invest conservatively. That may mean less money in stocks and more in bonds and low-risk investments like money market funds or FDIC- or NCUA-insured certificates. Alternatively, if you have decades before you need the money, you may want to invest more aggressively—since there’s time to ride out market fluctuations and the stock market tends to go up over time. Some financial planners say a good guideline is to subtract your age from 110-120 to determine what percentage you should have in stocks.
- Your risk tolerance: Investors who can ignore temporary market volatility might be able to tolerate the higher risk of stocks. If you’ll lose sleep during market dips, you may be happier with a more moderate level of risk, even if you may earn less.
Suppose you decide you can be moderately aggressive, but are uncertain where to start. In general, a moderate asset allocation could include 50-70% in stocks. Here’s an example:
60% in stocks >> 30% in bonds >> 10% in cash equivalents
Of course, your strategy for portfolio management will depend on your own circumstances and may change over time. It helps to get advice from a knowledgeable professional.
Diversification ensures you don’t have too much of your money in any one sector, industry or company. Instead, you put it in a mix of investment types. That way, you’re less likely to take a big hit if there’s a downturn that affects a single area. The old saying holds true here, “Don’t put all your eggs in one basket.” Here are some simple examples to illustrate why you should diversify.
Scenario 1. Suppose you have $5,000 to invest. You decide to buy 500 shares of a company that’s selling a hot new technology at $10 a share. In a short time, the stock soars to $30 a share. Wow! You’ve just potentially earned an extra $10,000. But…a new player comes on the scene with an even better technology. Pretty quickly, your company’s stock drops to just $5 a share reducing your initial investment of $5,000 to $2,500. Ouch.
Scenario 2. What would have happened if you had diversified? Suppose you had spread your $5,000 among a mix of investments. Let’s say:
- you bought stock in 5 different companies in a variety of industries for $1,000 each
- or you invested in a mix of stocks, a bond and a money market fund
- or you invested in some stocks and opened a savings account
If one of your stocks had had a downturn, your overall portfolio wouldn’t have been as affected as in Scenario 1. And, if one of your other companies experienced growth, it may even have offset the loss. Although a superstar stock can earn a lot, diversifying helps ensure you won’t lose as much if things go south.
Common Diversification Methods
Some of the more common methods investors use to diversify include:
- Investing by sector: Investors choose different companies within different sectors like energy, technology, transportation, banking and health care.
- Investing in funds: Funds include a mix of different securities all in one basket. Some investors prefer investing in funds as they offer more options than they could afford on their own and are often less volatile. For example, an S&P 500 Index Fund spreads your investment over a cross-section of companies and industries. It can be a good choice for those who want to invest across a broad swath of the economy.
- Investing by company size: Investors choose their securities based on the value of the companies they’re considering. Market capitalization looks at the total market value of all a company’s shares. They’re typically grouped as:
Mega-cap $200+ billion
Large-cap $10-$200 billion
Mid-cap $2-$10 billion
Small-cap $250 million-$2 billion
Micro-cap less than $250 million
Generally, investing in large-caps is considered a conservative strategy. Small- and micro-cap investments are considered more aggressive, particularly for start-up operations. And, mid-caps are a middle ground.
- Investing using robo-advisors: Many robo-advisors will do the work of diversifying for you—balancing market conditions against your finances, goals and risk tolerance. Navy Federal Investment Services Digital Investor makes investing easier. You can choose from fully automated, pre-built bundles or picking and managing your own investments.
- Investing by country: Although you can find some profitable foreign opportunities, some investors only invest in U.S. stocks. This is because there are rules and protections that may not be in place with foreign opportunities. Others take a more aggressive approach and include some foreign stocks in their portfolios. Keep in mind that foreign investing involves extra risks like currency fluctuations, political instability and accounting standards that are different from those in the U.S.
A Word About Diversifying Bonds
Bonds are generally lower risk investments than stocks, although not 100% risk free. That’s why you should also diversify your bonds—to make sure you don’t have too much invested in any one type or any one company. Here are 2 popular methods.
- By Sector: You can choose from among bonds issued by corporations, municipalities and the federal government. There are also mortgaged-backed bonds as well as non-US corporate and government bonds. U.S. Treasury bonds are backed by the full faith and credit of the U.S. government and are considered the least risky.
- By Maturity: You can find bonds that mature anywhere from 1-30 years. Earnings depend on the term and the issuer’s credit rating. Short-term bonds pay less, but longer-term bonds may pose more interest rate risk (the chance that if interest rates rise, bond prices could drop). Some experts suggest laddering—buying bonds that mature at different dates. This can help ensure a continual cash flow, while minimizing risks.
As with stock funds, you can more easily diversify your fixed-income portfolio by buying bond funds rather than individual bonds. Funds focus on specific maturity dates (short-, mid- and long-term), and bond ratings. These range from investment grade to junk bonds (low grade, riskier, but with higher rates). Bond funds require analysis to see how they might fit with your specific goals and risk tolerance.
3. Rebalancing & Reallocating
Rebalancing and reallocation isn’t a constant shuffling of one’s portfolio. They’re used in response to market changes or changes in your portfolio or preferences. In general, it means resetting your portfolio to align with your current asset allocation plan or changing your allocations to reflect new preferences. Ask yourself, “What percent do I want to devote to stocks, bonds or cash equivalents?”
Here’s how it might work in practice:
Certain events will cause you to liquidate some of your funds (e.g., paying for college, retirement). And, this change in your assets will mean you’ll probably need to change the allocation of your stocks, bonds and cash equivalents.
Another opportunity to rebalance is when interest rates trend up or down. For example, when interest rates were low, some brokers were advising clients to invest in a higher percentage of stocks (closer to 70% versus a 60/40 or 50/50 split between stocks and bonds). Be aware that by the time the average investor is aware of market shifts, portfolios probably have already been impacted. This is because institutional investors react to trends and change their portfolios in anticipation of change.
There are some funds that offer to automatically rebalance and reallocate for you. For example, you could consider an S&P 500 Index Fund or Russell 1000 Index Fund that adjusts its holdings based on the value of the index used. Or, there are exchange-traded funds (ETFs) or mutual funds for sector investing that will spread your dollars among a number of companies in a specific industry. Index funds, ETFs and mutual funds all require analysis and often professional advice to match these with your investment goals and risk tolerance.
What if you want to be more conservative or you want to focus on protecting your money? Then, you’d sell some of your stocks and increase your investments in bonds and cash equivalents. However, you should be aware of the tax consequences of selling assets in a taxable account. Explore tax-efficient ways to minimize the impact on your returns. Your tax advisor can help.
4. Dollar-Cost Averaging
One concern many investors have is knowing the best times to buy and sell to maximize their earnings. Enter dollar-cost averaging. Dollar-cost averaging is an investment strategy where you make consistent investments at regular intervals (e.g., monthly, quarterly). One example of dollar-cost averaging is a 401(k) or Thrift Savings Plan (TSP).
Advocates believe that dollar-cost averaging helps even out market highs and lows over time. Plus, since you’re investing regularly, you’re more likely to catch the great days. Historically, people who invest this way tend to have portfolios that perform better over time. One way to simplify this process is to set up automatic transfers from your bank to your investment account.
5. Value Investing
Value investing is a strategy that involves finding undervalued (underpriced) investments that have the potential for long-term growth. Its goal is earning a better-than-average dividend return. Investors typically look at companies’ financial statements, cash flows and other key metrics to identify promising opportunities for future growth in market value. Some of these metrics include the value of the stock in relationship to its multiple earnings or future earnings potential, or in relation to asset value.
Using this strategy, however, requires a significant time commitment and the ability to effectively analyze financial data. In addition to the time you’ll be spending searching out opportunities and researching the companies, you’ll need to be patient. It’s likely the stocks won’t increase in value quickly. It may even take years.
6. Growth Investing
Who wouldn’t love their investments to have rapid, high growth? Using a growth investing strategy has the potential to give you just that. You’d look for stocks most likely to increase in value faster than others in their industry or in the market in general. The goal is to eventually sell these stocks for a big profit. Some options might include new or niche companies that are likely to continue expanding. Others might be companies that are growing quickly or are unusually successful compared to competitors—especially those who have an outsized market share or likely to continue to expand over a long period. Technology stocks and new industries typically fall into this category.
With growth investing, you’ll need to do a fair amount of research. It’s important to stay current on financial news and market cycles. In a recent Forbes article, Marcia Wendorf suggested also searching for new patents and new (emerging) industries, and considering investing in growth mutual funds or ETFs to diversify your growth-oriented portfolio.
Three more things to keep in mind:
- While growth stocks can deliver substantial gains, they can also be more volatile. Investors need to carefully assess their risk tolerance when venturing into growth investing.
- Like their competitors, high growth companies often depend on financing. If rates rise and it becomes expensive to borrow, their growth may slow and their stock market value may be negatively impacted.
- These investments may not realize their full growth potential as quickly as you hope.
7. Active vs. Passive Investing
In a nutshell, passive investing is a buy-and-hold or set-it-and-forget-it strategy. Passive investors tend to buy into funds/indexes that do the work of managing and diversifying their portfolios for them. In general, investing in passive funds tends to mean less risk. And, because you aren’t frequently trading, you’re likely to pay less in fees and taxes. So, you have more money to spend on your investments.
Active investing, as you might expect, means you or a fund manager take an active role in researching, buying and selling stocks, closely following and regularly managing your portfolio. A big benefit of active investing is flexibility. With active investing, you’re more likely to be able to take advantage of short-term opportunities. You’ll also know quickly when stocks aren’t performing well or they become too risky. But, you can also have a mix of investments—some that are managed for you and some you manage yourself. Be aware that there’s typically a broker fee when buying and selling.
It’s always a good idea to talk to a financial advisor or certified financial planner to help you gain perspective. Navy Federal has a staff of dedicated financial advisors who can help you take the guesswork out of investing.1 They can evaluate your priorities and outline strategies for growth. Even better, they’re available onsite in more than 150 branches or by phone nationwide. You can find one near you by visiting our advisor locator page.
1Navy Federal Financial Group, LLC (NFFG) is a licensed insurance agency. Non-deposit investments, brokerage, and advisory products are only sold through Navy Federal Investment Services, LLC (NFIS), a member of FINRA/SIPC and an SEC registered investment advisory firm. NFIS is a wholly owned subsidiary of NFFG. Insurance products are offered through NFFG and NFIS. These products are not NCUA/NCUSIF or otherwise federally insured, are not guaranteed or obligations of Navy Federal Credit Union (NFCU), are not offered, recommended, sanctioned, or encouraged by the federal government, and may involve investment risk, including possible loss of principal. Deposit products and related services are provided by NFCU. Digital Investor offered through NFIS. Financial Advisors are employees of NFFG, and they are employees and registered representatives of NFIS. NFIS and NFFG are affiliated companies under the common control of NFCU. Call 1-877-221-8108 for further information.
This content is intended to provide general information and shouldn't be considered legal, tax or financial advice. It's always a good idea to consult a tax or financial advisor for specific information on how certain laws apply to your situation and about your individual financial situation.