Investing Basics
Here are a few approaches to buying stocks that every investor should understand.
Written by MoneyTalk Staff
on May 12, 2023
Illustration Veronica Park
Table of Contents
- Passive investing
- Value investing
- Growth investing
- Momentum investing
- Dividend investing
- Buy-and-hold investing
- Dollar-cost averaging
- Which investing strategy is for you?
Investing involves a lot more than simply buying and selling stocks. To be successful, you need a strategy — an approach or system that helps inform your investment decisions.
For instance, if you’re a bargain hunter by nature, you might gravitate to value investing. If you obsess over the latest trends, then growth investing may appeal as it involves seeking out stock opportunities before they make it big. Or maybe you’re most interested in a passive strategy where you can focus on growing your assets without the stress of selecting individual companies. As always, you should do your research before investing, know the risks and understand that returns are never guaranteed. The following examples are strategies that have helped investors grow their portfolios. Over time, you’ll learn which strategy best suits your personality.
Here are some common investment strategies to get you started:
Passive investing
Passive investors have no interest in beating broader market benchmarks, which, as countless research shows, is difficult even for professional managers to do. With this strategy — and the underlying philosophy behind indexing investing — you’re simply buying low-cost ETFs or index funds that match the weighting of a broad stock-market index like the S&P 500 or S&P/TSX Composite. Your returns will generally be in line with broader stock markets. This approach also allows you to steer clear of the time-consuming task of picking individual stocks.
Value investing
Value investing — a strategy made popular by the famous investor Warren Buffet — involves buying inexpensive or out of favour stocks that still have a good business model and strong financials. The goal here is to buy these stocks at a discount and wait until the market recognizes their value.
Knowing whether a stock is cheap or expensive can be challenging, since value isn’t usually related to the actual dollar value of the stock. Instead, you need to look at ratios such as price-to-earnings (P/E), price-to-book-value (P/B) or high dividend yields for clues. Because different industries, geographic regions and types of stock support different P/E and P/B, it’s best to compare each individual stock with its peers. Keep in mind these measures may not apply to startup companies with no earnings. Value investors might buy a stock at lower-than-normal P/E and then take profits if and when the P/E — and the share price — climbs.
Growth investing
Growth investors seek out companies that demonstrate above-average growth in metrics like revenues, profits and sales. Followers of this strategy believe a company’s share price will continue to rise as long as it can maintain that growth trend. Growth stocks have historically done well in rising, or “bull,” markets, but they can be susceptible to market downturns or to having their growth streak interrupted. This approach is often associated with technology and consumer discretionary stocks pioneering a new market opportunity.
Momentum investing
Momentum investing is a little like growth investing, but rather than watching sales and earnings, you might invest in companies that have seen their stocks rise in value recently. Momentum investors will typically hold a rising stock for a set period (say, six months) or until it falls again by a certain amount (say, 10%). Some may favour even shorter holding periods. Because momentum investing involves lots of buying and selling, this strategy can be more volatile and result in higher trading fees that eat into your returns. It may be best suited to very active investors using accounts with low transaction costs. You can also research a momentum-themed mutual fund or ETF where a portfolio manager handles the trading.
Dividend investing
Dividend investing is the practice of buying stocks in a company that is in a strong financial position, has a history of paying a dividend and, ideally, a track record of growing their payout. Dividend stocks have historically outperformed the S&P/TSX Composite. One of the reasons investors tend to like dividend-paying companies is because they offer two types of return: the dividend payment, which provides a source of income, and the capital appreciation of the stock. This approach can be particularly popular with retirees seeking an income stream to cover their living expenses without having to sell their stocks. However, younger investors can also benefit from reinvesting dividends to grow their wealth over time. Dividend stocks also tend to soften the blow of market downturns, both in the income they provide and their relatively low volatility.
Buy-and-hold
As the name suggests, once you begin actively researching which stocks or funds to own, you may find yourself holding onto those assets for an extended period. With this strategy, you might largely ignore short-term fluctuations in value if you believe the asset will rise over time.
A look back at historical market performance bears this out. Despite experiencing some considerable turmoil over the past 40 years, the Dow Jones Industrial Average is up more than 2,600%. Similarly, some individual companies frequently weather periods of volatility and go on to reward investors over time. It’s worth noting, however, that you may assume more risk when you invest in a single company versus a diversified ETF that tracks a major index. Riding out periods of volatility can be nerve-racking at the time, but if you look back at some of those up and down periods, you may find they’re barely a blip on the stock chart.
The buy-and-hold approach can also help you manage fees you might otherwise incur when you frequently buy and sell investments. And since you only get taxed on your capital gains once you sell your investments, holding your investments for a longer period will allow you to defer your tax bill. This can be a benefit if you are investing outside of a registered account because you may elect to take gains at a time when your taxable income is lower — such as during retirement.
Dollar-cost averaging
Dollar-cost averaging is not about what you invest in, it’s about how you buy your investments. Rather than purchasing a large number of shares at once, you invest the same amount of money at regular intervals, regardless of market conditions. The idea here is that by buying the same stock over time, you can minimize the impact of volatility because you’ll likely buy more shares when they are cheap and fewer when they are expensive.
While this strategy has served many investors well, it has some drawbacks. As much as buy-and-hold can help you tune out short-term distractions, you shouldn’t ignore your investment entirely. Occasionally, you will want to rebalance your positions to ensure a single type of holding doesn’t make up too much of your portfolio. You’ll also need to be aware if the market changes significantly. For instance, the video rental chain Blockbuster was a popular stock in the early 2000s, but it lost all its value when the company failed to adapt to online streaming. In other words, it’s still a good idea to pay attention to the companies in your portfolio.
Which investing strategy is for you?
These are some basic strategies, but there are many more, including hybrids that combine some of the features of the strategies outlined here. For instance, combining growth and value investing gives us something called “GAARP” — growth at a reasonable price. A dividend growth strategy is one that targets companies expected to raise their dividends.
If you don’t know what kind of investor you are yet, don’t worry. More than one approach can work for you, depending on your circ*mstances. Eventually, like your fashion sense, your investing style will come to you.
More you might like
Related Posts
DISCLAIMER: The information contained herein has been provided by TD Wealth and is for information purposes only. The information has been drawn from sources believed to be reliable. The information does not provide financial, legal, tax or investment advice. Particular investment, tax, or trading strategies should be evaluated relative to each individual's objectives and risk tolerance.
TD Wealth represents the products and services offered by TD Waterhouse Canada Inc., TD Waterhouse Private Investment Counsel Inc., TD Wealth Private Banking (offered by The Toronto-Dominion Bank) and TD Wealth Private Trust (offered by The Canada Trust Company).
TD Wealth Private Wealth Management represents the products and services available through TD Wealth Private Investment Advice (a division of TD Waterhouse Canada Inc.), TD Wealth Private Investment Counsel (offered by TD Waterhouse Private Investment Counsel Inc.), TD Wealth Private Banking (offered by The Toronto-Dominion Bank) and TD Wealth Private Trust (offered by The Canada Trust Company).
®The TD logo and other TD trademarks are the property of The Toronto-Dominion Bank or its subsidiaries.
- What is equity?
- Understanding the basics of partial shares
- What are fixed income investments?