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Investing strategies 101

Let's face facts. For a while there, investing was so easy that a chimpanzee could make money in the stock market.

Unfortunately, reality reared its ugly head and all those high-flying portfolios with their paper profits came crashing back to earth. That's when a lot of monkeys who thought that getting rich in the market was easy discovered that ignorance wasn't simply bliss, it was also hazardous to your wealth.

Think about it. If putting together a profitable portfolio was all that easy, why wasn't everybody rich already?

Still, despite occasional carnage on Wall Street, people do build fortunes in the stock market. Over the long haul, investors with a sound strategy make money during the good times and hold onto their cash through the hard times.

The question, of course, is: Which sound strategy?

There are several, it turns out, and experts disagree over which is best. But most of the experts do agree that what's most important is to have a strategy and stick with it through markets both bull and bear.

To help you make a choice, we've defined the five most-popular investment strategies, so you can see how they compare.

1. Buy and hold: This is the most conservative and most boring way to trade stocks. But it may also be the most efficient. Investors simply choose quality stable or blue chip stocks and hold them for many years.

Long-term investors don't worry about market fluctuations because they figure that their stocks will have time to recover from a down market. No more looking at the stock ticker every 15 minutes. Just sit back, relax and wait for your rewards. You also save a bundle on broker commissions because you're not paying for frequent transactions.

The catch is that choosing the right time to sell your investments can be tricky. You can counter this problem somewhat by knowing in advance when you'll need the money.

2. Short-term trading: This method was a favorite for people looking to make a quick buck, but lately they've taken their lumps. Basically, it involves buying and then rapidly selling stocks to capitalize on volatile markets. Day traders can win or lose a fortune in a single day.

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The problem with short-term trading is that you're bound to lose money in the long run. Want proof? Let's say your portfolio matched the S&P 500 Index. Look what would have happened if you, in an attempt to time the market, had missed some of the best days on Wall Street over 10 years.

S&P 500 Annualized total return
(Dec. 31, 1989 - Dec. 31, 1999)
Fully vested 18.21%
Missed best 10 days 13.84%
Missed best 20 days 10.80%
Missed best 30 days 8.26%
Missed best 40 days 5.95%
Source: Cassaday & Company Inc.

"The primary reason why it doesn't work is that mathematically if you're buying and selling on an ongoing basis, it's what's called a zero sum game," says Stephan Cassaday, a certified financial planner in McLean, Va. "At some point you will certainly have some winners, but you'll also have losers."

3. Asset allocation: The way this strategy works is by diversifying your portfolio into various asset classes (stocks, bonds, cash) rather than focusing on individual stocks.

For example, you could create a global equity portfolio made up of 80 percent U.S. companies and 20 percent international stocks. Then you'd further subdivide that portfolio between small and large companies both here and abroad.

This method minimizes your risk, but it also lessens the chance that you'll strike it rich because you're not heavily invested in one area. In other words, you won't strike out, but you're also not likely to hit a home run either. Still, many financial planners prefer the safety of having steady, though unspectacular, returns.

"The most secure way to making money in stocks is to have a broadly diversified portfolio and to hold it for long periods of time," Cassaday says. "Depending on the array of stocks that you choose, the results will be different. But they'll almost always be positive over five-year periods and certainly over 10 and 20 year periods."

"Asset allocation is going to give someone the most consistent rate of return over the longest period," adds Jim Maher, a certified financial planner in Deerfield Beach, Fla. "It takes the guesswork out of choosing individual investments. It eliminates market timing. That's what it's supposed to do."

4. Investment systems: There are dozens of systems that promote themselves as a guaranteed way to beat the market. Most of these are just marketing gimmicks designed to sell books and attract financial seminar goers. However, some systems have performed well for certain periods.

One of the most popular systems was called the Dogs of the Dow, which is updated annually. Here's how it works: You invest in the 10 highest yielding Dow Jones Industrial Average stocks. If your stock falls out of the top 10, then it's time to buy the new dog stock to replace the other one. The Dow measures the overall change in the stock value of 30 of the largest firms in the United States. The highest yielding stocks are those that are paying the highest dividends.

For several years, betting on the Dogs of the Dow proved more profitable than investing in all the stocks that comprise the Dow. But when tech stocks took over the market for a few years, the strategy lost favor.

Some experts say that was inevitable.

"Nothing like this will work consistently over a 20 to 30 year span," Maher says. "Think about it. If I found a surefire way to make a lot of money in the market, why would I tell anybody? Either to sell a book or because I can't make enough money doing what I'm telling everyone to do."

5. Dollar-cost averaging: This is one of the most reliable investment plans. If you have a 401(k) plan that automatically withdraws from your paycheck, you're dollar-cost averaging. To do it on your own, put a set amount into a mutual fund every month.

The neat thing about this system is you are buying more shares of stock (or funds) when the prices are low, like now, and you bought fewer shares when prices were high and the market was overvalued.

You can dollar-cost average by having money automatically withdrawn from a bank account, avoiding the need for a minimum deposit. Some mutual fund companies will waive the required minimum deposit if you agree to make automatic deposits each month.


-- Updated: May7, 2004

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See Also
QUIZ: Do you like risk?
Mutual fund numbers you need to know
Checking out your investment plan
Investing glossary
More investing stories

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