3Notes: Investing 201 Pt 2 – Investment Strategies


After going over Types of Investments, lets get an overview about some investing strategies and what they mean….

Long Strategy – This is the most basic of strategies. Investors select companies or industries they reasonably believe will grow over time, so they buy shares or debt in these entities. Basic buys of bonds or equities are considered long investments, or “longs.”

Value Investment – Value investors seek quality companies that are selling at a discount for some reason. Sometimes this is because of some negative press or scandal that causes a stock crash (see: Chipotle), offering an opportunity for value investors to buy a business after a pullback. In other situations, a business has a consistent track record of profits and usually dividend growth (i.e. Microsoft, Coca-Cola). Warren Buffett is perhaps the most famous of value investors.

Growth Investment – Growth investors look for companies with potential for rapid growth, typically in young or disruptive companies. There are some additional inherent risks, given the typical lack of dividend payment and shorter track record of successful results, but higher potential gain in principle. Technology companies are often found in this category, along with newer “sharing economy” businesses such as Air BnB and Uber.

Long Call Strategy – Calls are a bet on the rise of a stock price. The buyer of a call pays a premium for the option to buy an underlying asset from the market maker. If at expiration the stock is higher, the owner of the call receives the higher price minus the predetermined strike price minus the premium already paid for the option. Options are sold in 100 share increments. If the call price is $1, the strike price was $10, and the current price is $15, the owner earns a profit of $15(100)-$10(100)-$1(100) = $300. If the price is not higher, the owner can allow the option to expire and just loses their $1 premium paid.

Long Put Strategy – When an investor buys a put, they are conversely betting on the decline of the underlying asset. The investor pays a premium to claim the difference between the strike price and the lower price at the expiration. If the price has not declined, the investor only loses their premium paid, minus proceeds gained if the option is sold early.

Short Strategy – The short strategy is generally a “bearish” and/or contrarian stance that can be an enduring investing philosophy or representative of current outlook. This strategy involves short-selling, short puts, and short calls. This is a very risky method of investing, one that I do not recommend for regular investors.

Hedges are an important part of advanced portfolios. Investors use various methods to protect themselves from downside risks of assets they hold. For instance, a farmer may grow corn but also buy puts in corn to gain some profit if prices should fall. This protection is a hedge. Investors also use “safe haven” investments to serve as hedges, the most common being gold. Gold typically runs opposite of market booms, nearly always rising when fear in the market (volatility) rises. U.S. Treasurys and other respected sovereign bonds in developed nations also serve as safe havens. I recommend hedges for most, but only with the consultation of a professional or more seasoned investor to help you.

Stock picking versus indexing – It is difficult for people to make a career out of picking stocks. The smartest people can be destroyed by black swan events, yet the most unskilled can luck into picking a boomer that nets millions. Pick stocks at your own peril. Selecting index funds is “safer” for investors, as there is some baked in diversification in the asset. But remember, risk equals reward. Anytime you cut risk, you cut your upside. Plan according to your risk tolerance.

This dense post is all I will cover on strategy for now. Drop me a line for other strategies that you want to know about.

-Joe

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