By its very nature, investing is inherently risky. While it can be an incredibly powerful way to grow and accumulate wealth, sometimes investments go very wrong and end up losing money.
In this post we will look at some of the safest and soundest (though not the sexiest) investment strategies that have been proven to work in the long term.
Passive Investing Vs Active Investing
When it comes to investing, there are 2 main schools of thought; passive and active. Typically investors or wealth managers tend to strongly favour one approach over the other. Let’s look at what each one is, and how they compare to one another.
Active Investing
As the name suggests, active investing is a “hands on”, energy intensive approach to investment. The goal of active investing is to take advantage of the asset market fluctuations and to make relatively short trades.
While active investing offers the potential to make considerable profits fast, the risks are much higher too. Successful active investing requires a deep understanding of the markets and requires strong judgement (plus a dash of luck) as to the best time to buy or sell.
Active investing is not for the inexperienced, or the faint hearted.
Passive Investing
If Active Investing Aesop’s fabled hare, then Passive Investing is his turtle who proved that sometimes, slow and steady does win the race.
Passive investing basically entails purchasing an asset with the intention of holding it to make steady gains over the medium to long term. Passive investing is often considered to be a lot easier and safer than active investing although the returns are correspondingly less lucrative.
A classic example of passive investing is to buy an index fund that follows something like the S&P500.
Why Passive Investing Wins
Let’s get this straight, active investing can make traders very wealthy, very fast. However, the reality is that ‘beating the market’ is statistically unlikely. Many active investors suffer considerable losses on the way to success and some never recover from these losses. Furthermore, even a semi-successful active investor may see that their profits are being eaten up by the high volume of trading fees.
This is why many established investors favour a passive approach. There is a much lower risk of losing money, and as there is less buying and selling, there are less trading fees to eat into profits. There is also plenty of research that suggests that passive investing outperforms active investing over time.
Finally, Passive investing also allows traders to take advantage of dividends which we will explore in the next section.
Dividend Investing
A dividend is a share of profits payment that a company makes to shareholders (either annual or quarterly). Basically, an investor who owns a stock that pays dividends, receives a corresponding share of that company’s profits.
For example, if we buy 1 x $100 share in a company that pays a 3% dividend per share, we would receive a dividend of $3.
Dividend Investing is when an investor purposely seeks out stocks for their dividend value, rather than to potentially sell them on in the future. The benefit of dividend investing is that it offers a steady, passive income year upon year and typically, dividend investors look for big, well established companies such as large banks and energy giants. You can learn more about dividend investing with HALO Technologies.
In the example we gave above, it would take 30 years for the dividend to repay our initial stake of $100 which may make it an unattractive option for less patient investors. However, some stocks carry the option for dividends to be paid in the form of more stock – therefore after 10 years, our $100 share would now be a $130 share and as such, the dividend payment would be closer to $4. This kind of compounding and exponential growth makes passive, dividend investing incredibly powerful for long term investors.
Of course, dividend investing is not foolproof and if a company ceases to exist, then there are no evident payments. The 2008 financial crisis reminded us that even behemoth companies like Lehman Brothers can sometimes be wiped from the face of the stock market.
Indexing Investing
Index investing is a form of buy-and-hold passive investing that seeks to mimic the performance of a specific index; a collection of assets or securities. Index investors simply individually buy the core assets that make up a particular index fund – usually one of the top performing index funds.
The advantage of Index investing is that it effectively allows investors access to an index without the need for an asset manager thus saving on fees.
Final Thoughts on Successful Investing
The allure of active investing is obvious – buying low and selling high offers excitement and fast returns. However, the reality is that successful trades are usually counter-balanced by bad ones and of course, the high amount of fees further diminishes any profits that might be earned.
While passive investing like index investment is far less glamorous, it does provide much greater long term certainty and traders will also incur much lower fees. Novice investors can further mitigate risks by sticking to the best known dividend stocks and then reinvest the dividends to further grow the value of their investments.
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