Investment StrategyYou need to build stock picking strategies that are compatible with your risk profile and your personality. This will give you the best chance to attain your financial goal. Otherwise, you’ll eventually lose out to emotions. At the end of this important step, you’ll have answers to what type of stock screens is best for you. You’ll know:
Factors affecting your Investment Strategy include Timeframe, Risk Appetite, Tax Status, Portfolio size, Investment experience and knowledge, Psychology/Personality. The following table provides a general guideline as to what strategy is best for you depending on your situation. More details below.
Timeframe and Risk Appetite Go back to TopThe amount of risk you can take dictates what Market Cap, Investing Style and Holding Period is most appropriate for you.From Least to Most Volatile, portfolio factors can be classified as follows:  The amount of Risk you can take depends on:
Now, an important Risk management tool is Asset Allocation where you balance your portfolio's volatility with some Bonds or other conservative investments. Therefore, you can still invest in volatile strategies with only 2 to 5 years time horizon or if you have a medium risk tolerance. However, below 2 years time horizon or if you’re very risk adverse, apart from owning a larger portion in Bonds, you should stick to the very least volatile stock strategies: Large Cap Value with ≥1 year Holding period. Risk goes hand in hand with Returns: strategies focusing on Small Cap, Momentum and having short holding period (for instance CANSLIM), though most volatile, are also the ones that offer the greatest potential gains. Invest in those strategies only if you have a long time horizon ≥ 5 years and can temporary tolerate important losses on your capital. Account Type & Tax Status Go back to TopOn top of being Tax efficient, Tax Deferred accounts encourage a long term approach to investing. Maximize them first.Investment goals that require liquidation of portfolio before retirement obviously have to use Taxable accounts. Which strategy to use in which account depends on:
Now, combining Investment Style and Holding Period often leads to contradictions:
From the table, the only obvious choice is Growth Investing which can be used in Taxable account. For the remaining, as a rule of thumb, favors the Holding period rule - Capital Gains are usually higher than Dividends - so put Value in Taxable and Growth/Momentum in Tax Deferred. Note: Value Investing have proven to be very successful with long holding periods up to 5 years (David Dreman "Contrarian Investment Strategies - the next generation") so is really suitable in Taxable account. Obviously, if you’re not comfortable investing in Momentum strategies then you can use Value Investing in Tax Deferred. Check the Investment Returns Calculator to see the impact of Tax on your investment strategy. Portfolio Size Go back to TopIt is desirable to keep transaction costs as low as possible. Transaction costs include Buying/Selling fees, Account maintenance fee… but do not include Tax.Strive to keep costs below 1% of your portfolio and of course the lower the better. This implies that the smaller your portfolio size in terms of dollars, the fewer stocks you will be able to hold. If you have less than 10,000$ or cannot hold more than 10 stocks in your Portfolio, then focus on Large Cap / Value / Long Rebalancing frequency:
Experience and knowledge Go back to TopThe beauty of Mechanical Stock Picking is that you don’t need extensive knowledge to put it into practice. The hard job of academic studies and backtesting has already been done. You just need to apply successful backetested strategies to reap superior returns.However, I strongly recommend that you understand every single line item of any Stock Screening strategy you use. Specifically, I recommend that you understand why a criterion used in a screen provide superior performances. The easiest strategies to understand are Value and GARP (Growth At Reasonable Price) which are often very simple. I recommend beginner investors to stick to these as a start. Successful Growth Investing is more complex and Growth screens typically have more line items than Value screens. You may also require a more advanced stock screener. Successful Momentum Investing requires extreme control of one’s emotions as they are the most volatile. Jump into Growth or Momentum Investing only if you’re an intermediate to advanced investor. Psychology/Personality Go back to TopThere are 2 psychological biases you may want to consider when choosing your investment strategy. These 2 biases are somewhat opposite so you will unlikely be affected by both to the same extent but more by one or the other.The 2 biases are Fear of Regret / Loss Aversion and Herd Mentality If you suffer Fear of Regret / Loss Aversion, you tend to sell your winners too soon and keep onto your losers too long. In this case, a Value Investing strategy would be more adapted. If you/re affected by the Herd Mentality following the crowd, you jump into what's hot...but forget to sell, or press the panic button when market falls. If you find it too difficult to act against the herd, then adapt your strategy and use a Momentum approach with short holding period: you will be in what's hot most of the time but will benefit from shorter holding periods. You can now go back to the table summary to select the best Investment Strategy adapted to your situation. |
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