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5 Steps to Crafting an Investment Strategy

One of the first steps to take when beginning your foray into the world of investing is deciding on an investment strategy.

Generally speaking, you should decide on your goals when investing, how much risk you want to take (remembering that no investment is safe from some forms of risk), and then decide on the type of asset(s) you'll be putting your money into.

It is always strongly recommended to seek professional financial advice to help you determine your goals and strategy. The below information is merely an introduction of things to keep in mind before making investments.

The first step is to decide on your goals.

What is Your Goal?

Investments goals generally focus on when, and what type of returns you want to see. Are you interested in income returns (i.e. cash in hand) or capital gain (e.g. property value increasing over the years).

Income returns typically come from purchasing blue chip stocks (large, established companies e.g. Apple or BHP) and banking their dividends (distribution of a companies profit to shareholders). Day-trading (high volume trading) can also provide income returns, however this is much more risky.

Capital gain returns often come from selecting stocks that you expect to grow, or investing in property.

Next, you need to decide on the level of risk you're willing to take on.

Levels of Risk

Deciding on your level of risk will inform the type of asset class you're likely to invest in.

A low risk approach often favours blue chip stocks and property, as both assets are generally expected to increase their value in the mid to long term. Even if the market crashes tomorrow investors in the above asset classes often hold, or purchase more, as they believe in the value of their investment. This type of investing is known as Value Investing, for more information see our post here.

Lower risk investments are typically more stable, with the expectation of having increased returns in 10+ years. Long term investments may, however, include dividends to provide income whilst you wait for your return.

Investors with a high appetite for risk often engage in day-trading - attempting to predict future market movements with frequent trades. For more information see our post here.

Faster returns are typically riskier, or make smaller amounts of profit.

Now you can consider your asset classes.

Types of Asset Classes

An asset class is a group of financial instruments that have similar characteristics in the market.

Income assets include cash and bonds whilst growth assets are property, equities (stocks) and alternative investments (e.g. cryptocurrencies).

Within each asset class there is often a range of conservative to risky options. For example, an Exchange Traded Fund (ETF) is a collection of stocks that can be purchased by individual traders, much like buying a stake in a managed fund. These are generally thought to be less risky than investing in a single company, as you are diversifying your risk across multiple companies.

Diversification

Diversifying your portfolio is generally seen as a safe decision as it helps mitigate sudden market changes by spreading your investments across different sectors and asset classes. This can include investing in different sectors, such as small cap and blue chip stocks. Or by purchasing a combination of asset classes such as stocks, bonds, or property.

However, billionaire and value investor Warren Buffet has this to say about diversification:

"Diversification is protection against ignorance. It makes little sense if you know what you are doing."

It's important to understand that while Buffet holds such a view, he also has incredible knowledge, years of experience, and a team of highly skilled researchers working for him.

Research

Reading articles like these are only the first step to crafting your investment strategy. Read up on market reports and consumer sentiment. It's imperative to broadly understand the asset and the market before you make any investment.

For assistance in reviewing term sheets we recommend our 5 Key Factors to Understand Term Sheets.

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