Finding My Investment Style
Investing is a crucial component of any Financial Independence or Early Retirement Plan. It helped me pave a very comfortable lifestyle, financial independence, and early retirement. At its essence, building wealth is about reducing expenses and increasing income and investments was how I was able to increase my income significantly.
There are many types of investing and over the years I’ve come to realize that you need to find an investment philosophy that suits your individual personality. I have experimented with several types of investments over the years and have found a combination of styles that suit me. This combination of investing methodology has helped my wife and I retire early without being frugal. With that said, you still need to save more than you spend. But, you also need to enjoy life while you’re still young. I’m a strong believer in balance.
Here are some of the investment styles (I use this term loosely as some are more speculative in nature) I’ve been exposed to or experimented with over the years.
Mutual Funds are the products most people purchase when they start off in investing. They are a basket of securities (stocks, bonds, options etc) that are managed by a portfolio manager. The portfolio is owned by a pool of mutual fund investors or unit-holders. Mutual funds have systematic investment plans that allow investors to purchase small amounts of units on a monthly basis.
This is a good way for people starting out to automate their savings and investing. This definitely helped me initially build my capital. When I first invested in mutual funds the fees were still high and ETFs were not available. Now that commissions and fees are much lower there are other options available. If you want to invest in mutual funds, be aware of the management fees. Although fees are coming down, some are still relatively high compared to Exchange Traded Funds (ETFs).
Vanguard funds and ETFs are now one of the most popular with very low fees. Vanguard is a unique company that is structured differently whereby the ownership of the company is its unit-holders and not shareholders. This ensures better alignment of management and unit-holders. Fidelity recently launched two new zero fee funds; a US fund and an International fund. Here an article on CNBC.
Value investing is the investment style that was made popular by Warren Buffet and his mentor Benjamin Graham. With this style, you calculate the intrinsic value, what the company is actually worth per share if you sold off all its assets and paid off all debts, of the stock. A purchase is made when the stock price is below the intrinsic value. It’s like buying a stock on sale, the larger the discount the larger the margin of safety.
I learned about this method when I was much younger. Truth be told, I didn’t have the patience or the capital to make this method viable. Investing a few hundred dollars a month was all I was able to handle. I’ve committed to re-reading Security Analysis by Ben Graham & David Dodd and The Intelligent Investor by Ben Graham. I think I’ll have a much better appreciation for these books this time around.
Growth investing is the investment style that focuses on the future growth of a company. Investors of this style are not worried about purchasing a stock below intrinsic value, they are more concerned with the potential growth of a company. Amazon could be an example of a growth stock, it definitely was several years ago. If an investor believes Amazon will continue to grow its earnings in the future, they would purchase Amazon today based on their future growth estimates.
I didn’t have much success with this method. It was difficult finding the right companies, who knew 5 or 10 years ago Amazon was going to be where they are today. There wasn’t a systematic way of finding the next Amazon, Apple or Facebook.
Day Trading is when a trader buys and sells a single, or most likely multiple, positions in a single day. They generally use technical analysis or charts to determine entry and exit points (price). Technical analysis utilizes historical chart patterns and indicators to predict future price. The idea is to be in and out of a position within a day so you aren’t carrying a position overnight. Day trading requires strict discipline particularly on your exit points (especially if you’re carrying a loss). Risk management, or lack thereof, is what hurts most beginner day traders.
I personally don’t have the temperament for this type of trading. It’s also something you can’t do while holding a day job. I’ve read somewhere that over 90% of traders fail; I think that number is probably higher for day traders.
Swing trading is when a trader holds a position longer than a day and, typically, up to several weeks. This type of trader generally uses technical analysis for entry and exit points. Swing traders look for larger price movements than day traders. As with day trading, risk management is an important component of swing trading. Risk management includes strict rules regarding exit strategy, entry point, position size and strict control over emotions.
I’ve had more success with swing trading when trading solid dividend stocks. I’m much more disciplined and only enter trades when the probabilities are at the highest. It’s just as important to hold back and not overtrade. Only a small portion of my non-taxed trading account is allocated to swing trading. The majority is in dividend growth stocks.
Dividend investing is the investment style that focuses on dividends. These are payments that a company makes to its shareholders on a monthly or quarterly basis. Companies will also payout special one-time dividend (example Microsoft) when they have excess cash on hand. Also, there are various styles of dividend investing. Dividend yield investors focus on high yield now, these usually come from companies in mature industries with fewer growth opportunities. Alternatively, dividend growth investors look for companies with a history of growing their dividend payout every year. They are willing to forgo higher yields today with the anticipation of their dividend growing over time.
Most of my portfolio is in dividend growth. This investment style suits me the most. I enjoy seeing monthly or quarterly dividends deposited into my account. Combined with a selective dividend re-investment (DRIPS) plan, I see my positions grow (I’ll also talk more about DRIPS and why I now employ selective DRIPS in another post).
Options are products that are derived from another security (eg Stocks, Fixed Income, Commodities and even Real Estate). The most popular or well-known options are stock options (eg calls and puts). A call option provides the buyer with the right but not the obligation to buy a stock at a prearranged price (strike) before the expiration date. A put option provides the buyer with the right to sell a stock at a prearranged price before expiration. Options were originally developed as a hedging tool but now its probably used more for speculation by retail investors or hedge funds. I have never seen options used for speculation in institutional investment management in Canadian banking. They use it for hedging and to produce additional income (selling or writing options).
Warren Buffet called derivatives “financial weapons of mass destruction”, it can be riskier but if used correctly can actually reduce risk. Buffet himself, or Berkshire Hathaway, has made billions selling puts. Here is an article with the details. Thestreet.com.
I write cash-secured puts on dividends stocks I want to own and selectively write calls (I’ll get more into the details in another post).
ETFs and Pooled Funds
My exposure to ETFs and Pooled Funds was more a result of my recent role at an Asset Management firm. As part of the Institutional Investment Management team (Reporting & Sales Support), all my trades had to be precleared. It became too difficult to swing trade or even purchase individual securities during market corrections while in this role. Mutual funds, ETFs and pooled funds were the only securities we didn’t need to preclear. Pooled funds are similar to mutual funds but usually for institutional investors (eg pension funds, endowments, and ultra high net-worth families).
In the past 15 years, my wife and I have bought and sold 7 properties. Real Estate was and still is an important element in our path to financial independence and early retirement.
Finding your investment style is important to helping you achieve financial independence and early retirement. I’ve heard arguments with people sighting studies stating passive indexing (ETFs or index funds) is the best. Others that say dividend growth is the way to go. Some that say value investing will beat the other two. Personally, I don’t know which is the best but I do know what has worked for me. How ‘hands-on’ you want to be is what will help you choose your style. At the end of the day, what’s important is to find an investment style that you’re comfortable with. One that manages risks and allows you to sleep at night.
What is your investment style?