Active women can be passive investors
I am an active woman - I will of course be an active investor! If these thoughts just crossed your mind, think twice.
Before you take any decision, learn about investment strategies.
You may prefer to become a passive investor after all, which could save you time. But let’s take a step back and look at the bigger picture: The first time I heard the word investment strategy, I had no clue what it means. My strategy was to “make money”. But in order to do so, you need a investment strategy. This sounds impressive, maybe even intimating. But all you need to do is to define criteria based upon which you take investment decisions. To make it easier for you to understand, I divided them into different levels.
Level 1 - Active vs. Passive investing: The first decision you take is to invest actively vs. passively. Active investing is nothing else than stock picking. This entails using certain criteria to evaluate and hold a specific stock. The objective of stock picking is to generate higher returns. Be aware that it often requires you to invest more time as you track your holdings and also have to identify the right stocks and the right timing.
Level 2 - Asset Allocation: Another way to describe an asset allocation is: your investment decisions has been turned into reality - in the shape of an investment portfolio. The asset allocation is based on two principles: risk profile and diversification.
Level 3 - Stockpicking 101: You choose your stocks based on principles, such as value investing, growth investing, dividend strategy, and buy & hold.
Let’s dive into the details!
Level 1 - Active vs. Passive investing
The first decision you take is to invest actively vs. passively. Active investing means you will engage stock picking. This entails using certain criteria to evaluate and hold a specific stock. The idea of stock picking is to generate higher returns. Be aware that it often requires you to invest more time as you track your holdings and also engage in identifying the right stocks and the right timing.
With passive investing on the other hand you would achieve only market average returns by investing in ETFs (exchange traded funds). Not more but also not less. When investing in ETFs, you choose an index (e.g. S&P 500, DAX or MSCI World) which contains a preset of securities defined by the index. For example the DAX index includes the 30 biggest stock listed companies in Germany, hence an ETF based on the DAX invests in these 30 biggest companies. If you would want to buy individual shares of all 30 companies, you would have to make a quite extensive investment. By investing in an ETF, you participate in a fund which holds the shares. What does this imply? You hold a certain % of the funds, hence a % of these shares. Why is this called passive investing? Because the index defines which stocks are included in it. In the case of the DAX, the index covers the 30 biggest companies in Germany.
Level 2 - Asset Allocation
Your asset allocation is nothing else than your investment decisions turned into reality - an investment portfolio.
The asset allocation combines two principles:
Risk profile: You define your risk profile based on your situation (e.g. age, risk tolerance, investment amount, investment goal, investment horizon). The risk profile then defines how much % of your asset should be allocated to the security buckets (e.g. cash or AAA bonds) or growth bucket (e.g. stocks, commodities, real estate).
Diversification: Within your allocation of security and growth you then select an asset class (e.g. stocks) and its focus (e.g. Emerging Markets). An asset allocation should be diversified: you do not only select different asset classes (e.g. stock, bonds, commodities) but also diversify within an asset class (e.g. in stocks different regions, different industries). This is why investing via ETFs is relatively easy to implement as you can select one ETF (e.g. MSCI World) and invest in multiple countries (e.g. MSCI World 23 countries) and companies (e.g. MSCI World over 1.600 companies).
Level 3 - Stock picking 101
As part of stock picking, you choose your stocks based on principles, such as value investing, growth investing, dividend strategy, and buy & hold.
Value investing - Value investing means selecting stocks based on their value, the main idea here is to find stocks which are currently undervalued with the idea that the stock price will increase to match the actual value of the company, this is when value investors materialize their profits. Warren Buffet, one of the most successful investor used this strategy. To find undervalued stock one would need to look at different fundamental data of the respective company e.g. profit, revenues, debt and other ratios (e.g. earning per share etc.). Value investing means applying consistently the same rules which if understood makes it easy to apply, but also is time intensive.
Growth investing - This strategy consists of mainly investing in growth stocks, stock of companies which are expected to grow at a faster rate than conventional stocks. For example, these can stocks from the tech industry (think Tencent from China). The main advantage of buying these stocks is that they are expected to generate higher than average returns. No return without risk: these stocks can be rather speculative. Again, this approach is time-intensive. It is not recommended for beginners as different aspects need to be evaluated of a stock which are not (well) known yet (e.g. profitability).
Dividend strategy - This strategy encompasses selecting those stocks which provide a high and regular dividend payout. Dividend stocks often are issued by more traditional companies (think BASF, Ford Motors). What is the benefit of pursuing a dividend strategy? It generates a passive income stream through dividends. Ideally, the dividends are re-invested to leverage the compound interest effect. Note: a company’s stock should not solely be bought based on dividend payouts - an evaluation of the stock is also required. Again, time needs to be invested to identify the “right” stock.
Buy & hold - This means mainly to buy a well valued stock and keep that stock, hence after deciding you would keep that stock for 20-30 years. Of you first need to find a good stock first, hence an evaluation is necessary but after that you can leave it.
All four strategies can be implemented with individual stocks or ETFs. If you opt for ETFs you can use websites such as justetf.com to look for either value, growth or dividend stock based ETFs. The buy & hold approach is crucial to keep your investments for the long term. Note that all four strategies are medium to long-term oriented. We at Finelles do not provide short term investing tips, but provide you with knowledge to invest long-term.
Active or passive investing - which approach is right for you?
If you are new to investing we recommend to passive investing: define your asset allocation and then choose a combination of ETFs which include multiple region and companies (value, growth and dividend) as well as assets (bonds, stocks, commodities and real estate) depending on your investment amount. That is it, so the next step is just to implement your strategy. Peter Drucker ones said “Culture eats strategy for breakfast”, in investing terms this should be “Execution eats strategy for breakfast”.
Practical tip: you can calculate your risk profile and asset allocation for example with the justetf strategy builder (https://www.justetf.com/de/etf-strategy-builder.html), which allows you to select also your focus in your stocks, bonds and additional assets (e.g. commodities).
Written by Clara Creitz
Finelles Founder. Coach and Consultant (UBS, Towers Watson).