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  • Writer's pictureRaj Sukkersudha, Founder of Denver Capital

Investment Styles: Which One Suits You?




Have you ever considered your investment style? Chances are, if you’re like most investors, it hasn’t received much of your attention. Yet, gaining a fundamental grasp of the major investment approaches is a swift way to navigate the plethora of investment options available in today’s market.

These investment styles can be categorised along three key dimensions: active vs. passive management, growth vs. value investing, and small-cap vs. large-cap companies. Evaluating your preferences within each of these dimensions will provide valuable insights into the investment approaches that best align with your financial goals.

Active or Passive Management

In determining your investment approach, the first factor to contemplate is the extent to which you believe financial experts can deliver returns exceeding the norm.

Investors who seek professional money managers to meticulously curate their portfolios tend to favor active management. Actively managed funds typically employ a full-time team of financial researchers and portfolio managers dedicated to consistently achieving superior returns for investors. It’s important to note that actively managed funds often come with higher expenses, reflecting the cost of this expertise.

However, some investors harbor doubts about the ability of active managers to consistently deliver outsized returns. These doubts are supported by empirical research showing that over the long term, many passive funds outperform similar actively managed counterparts.

Passively managed funds have an inherent advantage — they don’t require the services of dedicated researchers, resulting in typically lower expenses.

Investment Strategies: Growth vs. Value Investing

The next consideration for investors pertains to their preference for either investing in rapidly growing companies or undervalued industry leaders. Analysts employ financial metrics and judgment to categorise companies into either of these two groups.

Growth-Style Investing

Growth-style investing seeks out firms with high earnings growth rates, high return on equity, robust profit margins, and low dividend yields. The underlying idea is that companies with these characteristics are often innovators in their respective fields, rapidly growing and reinvesting most or all of their earnings to fuel future growth.

Value-Style Investing

Conversely, value-style investing revolves around purchasing strong firms at favorable prices. Analysts look for low price-to-earnings ratios, low price-to-sales ratios, and generally higher dividend yields. Key ratios for the value style underscore its focus on the purchase price.

Company Choices: Small Cap vs. Large Cap Enterprises

The final consideration for investors pertains to their preference for investing in small or large companies. A company’s size is gauged using “market capitalisation” or simply “cap.” Market capitalisation is calculated by multiplying the number of outstanding shares by the share price.

Small Cap Enterprises

Some investors believe that small-cap companies have the potential to yield better returns due to their growth opportunities and agility. However, this potential for higher returns comes with increased risk. Smaller firms often have fewer resources and less diversified business lines. Consequently, share prices can exhibit more significant fluctuations, resulting in substantial gains or losses. Investors must be comfortable with assuming this additional level of risk if they wish to tap into the potential for higher returns.

Large Cap Enterprises

For more risk-averse investors, large-cap stocks may offer greater reassurance. Among large caps, you’ll encounter well-known names such as Apple, Amazon, and Microsoft. These companies have established themselves as industry giants over the years. While they may not experience rapid growth due to their size, they are also less likely to face unexpected financial troubles. From large caps, investors can anticipate slightly lower returns than with small caps, but with reduced risk as well.

Conclusion

Investors should carefully contemplate their stance on each of these three dimensions of investment style. Defining your investment approach will guide your selection of investments that align with your long-term financial objectives.

 

IMPORTANT: This content is accurate and true to the best of the author’s knowledge and is not meant to substitute for formal and individualised advice from a qualified professional.



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