Topic: ETFs

Stock Investment Strategies: ETFs, Diversification, and Compound Interest

stock investment strategies

The best stock investment strategies include lowering your risk, cutting fees and putting time on your side

Long-term stock investment strategies aren’t built by aiming to make a fast dollar, or trying to profit from inside information. They are built over time, and most important, by learning how not to repeat the market mistakes of the past.

To begin, you should invest in companies that have the ability to profit from secular trends. These are companies that can take advantage of trends that go far beyond mere business cycles and reflect ongoing changes in society. Examples include economic liberalization, the ongoing retirement of baby boomers, and the productivity gains available from continually evolving computer and communications technology.

Here are three time-tested stock investment strategies:


Less likely to harbour hidden risks

“Here’s a good general rule to follow when choosing investments: Simple is better. The easier an investment is to explain and understand, the less likely it is to harbour hidden risks and costs that can only work against you. As the old investor saying goes, “Stick with plain vanilla.”
Pat McKeough explains why in this special report and recommends 11 ETFs for a stronger portfolio.

 

Read this FREE report >>

 


Stock investment strategies: ETFs

An ETF investment is one of the most popular and most benign investing innovations of our time. ETF investments are a little like conventional mutual funds, but with two key differences.

The MER (Management Expense Ratio) is generally much lower on ETFs than on conventional mutual funds. That’s because most ETFs take a much simpler approach to investing. Instead of actively managing clients’ investments, ETF providers invest so as to mirror the holdings and performance of a particular stock-market index.

ETFs practice this “passive” fund management, in contrast to the “active” management that conventional mutual funds provide at much higher costs. Traditional ETFs stick with passive management—they follow the lead of the sponsor of the index (for example, Standard & Poors). Sponsors of stock indexes do from time to time change the stocks that make up the index, but generally only when the market weighting of stocks change. They don’t attempt to pick and choose which stocks they think have the best prospects.

This traditional, passive style also keeps turnover very low, and that in turn keeps trading costs for your ETF investment down.

As well, with the best ETFs you won’t incur the regular capital gains taxes generated by the yearly distributions most conventional mutual funds pay out to unit-holders.

Stock investment strategies: Diversification

Building a balanced portfolio can include a mix of growth and value stocks, big and small stocks, and so on. But most important, it should be balanced across most if not all of the five economic sectors.

Here are some more tips on diversifying your stock portfolio:

  • When it comes to a diversified stock portfolio, stocks in the Resources and Manufacturing & Industry sectors in general expose you to above-average share price volatility.
  • Stocks in the Utilities and Canadian Finance sectors entail below-average volatility.
  • Consumer stocks fall in the middle, between volatile Resources and Manufacturing companies, and the more stable Canadian Finance and Utilities companies.

Most investors should have investments in most, if not all, of these five sectors. The proper proportions for you depend on your temperament and circumstances.

Conservative or income-seeking investors may want to emphasize utilities and Canadian banks for their high and generally secure dividends.

More aggressive investors might want to increase their portfolio weightings in Resources or Manufacturing stocks. For example, more aggressive investors could consider holding as much as, say, 25% to 30% of their portfolios in Resources. However, you’ll want to spread your Resource holdings out among oil and gas, metals and other resources stocks for diversification within the sector, and for exposure to a number of commodities.

Stock investment strategies: Compound Interest

Compound interest can be considered the mother of all long-term investment strategies because it can have an enormous ballooning effect on the value of an investment over time. This tip is especially important for young investors to learn. This stock trading tip’s benefits apply to both stock and fixed-return, interest-paying investments, like bonds. When you earn a return on past returns, the value of your investment can multiply. Instead of rising at a steady rate, the number of dollars in your portfolio will grow at an accelerating rate.

To profit from this tip, you need to pay attention to steady drains on your capital, even seemingly small ones—like high brokerage commissions, say. If you’re losing (or missing out on a profit of) even 1% a year, it can have an enormous draining effect on your investments over a decade or two.

More stock investment strategies for successful investors

In our view, your goal as an investor, particularly if you follow a conservative investing strategy like the one we recommend, is to make an attractive return on your investments over a period of years or decades. Failure means making bad investments that leave you with meagre profits or losses.

Unsuccessful investors can still make some profits. They just don’t make enough to offset the inevitable losses and leave themselves with an attractive return. If you focus on the idea that you never go broke taking a profit, you may be tempted to sell your best investments whenever it seems the investment outlook is clouding over.

Which investing strategy do you rely on most for long-term gains and limited risk?

Most investors alter their investing strategies over time. Do you have a strategy that seemed like a good idea, but turned out to be a mistake?

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