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When you start investing on your own, the world of investing may seem wide, often too wide. But you can simplify things with some time-tested strategies. A solid investing strategy can lead to good returns over time and allows you to focus on other parts of the investing process or even makes investing so easy that you can spend more time on what you love to do.
Here are five popular investment strategies for beginners, along with some of their advantages and risks.
Top investment strategies for beginners
A good investment strategy minimizes your risks while optimizing your potential returns. But with any strategy it’s vital to remember that you can lose money in the short run if you’re investing in market-based securities such as stocks and bonds. A good investment strategy often takes time to work should not be considered a “get rich quick” scheme. So it’s important to begin investing with realistic expectations of what you can and can’t achieve.
1. Buy and hold
A buy-and-hold strategy is a classic that’s proven itself over and over. With this strategy you do exactly what the name suggests: you buy an investment and then hold it indefinitely. Ideally, you’ll never sell the investment, but you should look to own it for at least 3 to 5 years.
Advantages: The buy-and-hold strategy focuses you on the long term and thinking like an owner, so you avoid the active trading that hurts the returns of most investors. Your success depends on how the underlying business performs over time. And this is how you can ultimately find the stock market’s biggest winners and possibly earn hundreds of times your original investment.
The beauty of this approach is that if you commit to never selling, then you don’t ever have to think about it again. If you never sell, you’ll avoid capital gains taxes, a return killer. A long-term buy-and-hold strategy means you’re not always focused on the market – unlike traders – so you can spend time doing things you love instead of being chained to watching the market all day.
Risks: To succeed with this strategy, you’ll need to avoid the temptation to sell when the market gets rough. You’ll have to endure the market’s sometimes-steep falls, and a 50 percent or greater drop is possible, with individual stocks potentially falling even more. That’s easier said than done.
2. Buy the index
This strategy is all about finding an attractive stock index and then buying an index fund based on it. Two popular indexes are the Standard & Poor’s 500 and the Nasdaq Composite. Each has many of the market’s top stocks, giving you a well-diversified collection of investments, even if it’s the only investment you own. (This list of best index funds can get you started.) Rather than trying to beat the market, you simply own the market through the fund and get its returns.
Advantages: Buying an index is a simple approach that can yield great results, especially when you pair it with a buy-and-hold mentality. Your return will be the weighted average of the index’s assets. And with a diversified portfolio, you’ll have lower risk than owning just a few stocks. Plus, you won’t have to analyze individual stocks to invest in, so it requires much less work, meaning you have time to spend on other fun things while your money works for you.
Risks: Investing in stocks can be risky but owning a diversified portfolio of stocks is considered a safer way to do it. But if you want to achieve the market’s long-term returns – an average 10 percent annually for the S&P 500 – you’ll need to hold on through the tough times and not sell. Also, because you’re buying a collection of stocks, you’ll get their average return, not the return of the hottest stocks. That said, most investors, even the pros, struggle to beat the indexes over time.
3. Index and a few
The “index and a few” strategy is a way to use the index fund strategy and then add a few small positions to the portfolio. For example, you might have 94 percent of your money in index funds and 3 percent in each of Apple and Amazon. This is a good way for beginners to keep to a mostly lower-risk index strategy but add a little exposure to individual stocks that they like.
Advantages: This strategy takes the best of the index fund strategy – lower risk, less work, good potential returns – and lets the more ambitious investors add a few positions. The individual positions can help beginners get their feet wet on analyzing and investing in stocks, while not costing too much if these investments don’t work out well.
Risks: As long as the individual positions remain a relatively small portion of the portfolio, the risks here are mostly the same as buying the index. You’ll still tend to get around the market’s average return, unless you own a lot of really good or poor individual stocks. Of course, if you’re planning on taking positions in individual stocks, you’ll want to put the time and effort into understanding how to analyze them before you invest. Otherwise, your portfolio could take a hit.
4. Income investing
Income investing is owning investments that produce cash payouts, often dividend stocks and bonds. Part of your return comes in the form of hard cash, which you can use for anything you want, or you can reinvest the payouts into more stocks and bonds. If you own income stocks, you could also still enjoy the benefits of capital gains in addition to the cash income. (Here are some top dividend ETFs you may want to consider.)
Advantages: You can easily implement an income investing strategy using index funds or other income-focused funds, so you don’t have to pick individual stocks and bonds here. Income investments tend to fluctuate less than other kinds of investments, and you have the safety of a regular cash payout from your investments. Plus, high-quality dividend stocks tend to increase their payouts over time, raising how much you get paid with no extra work on your part.
Risks: While lower risk than stocks generally, income stocks are still stocks, so they can fall, too. And if you’re investing in individual stocks, they can cut their dividends, even to zero, leaving you with no payout and a capital loss, as well. The low payouts on many bonds make them unattractive, especially since you’re not likely to enjoy much or any capital appreciation on them. So, returns from bonds may not even beat inflation, leaving you with reduced purchasing power. Also, if you own bonds and dividend stocks in a regular brokerage account, you’ll have to pay taxes on the income, so you may want to hold these assets in a retirement account such as an IRA.
5. Dollar-cost averaging
Dollar-cost averaging is the practice of adding money into your investments at regular intervals. For example, you may determine that you can invest $500 a month. So each month you put $500 to work, regardless of what the market is doing. Or maybe you add $125 each week instead. By regularly purchasing an investment, you’re spreading out your buy points.
Advantages: By spreading out your buy points, you’re avoiding the risk of “timing the market,” meaning the risk of dumping all your money in at once. Dollar-cost averaging means you’ll get an average purchase price over time, ensuring that you’re not buying too high. Dollar-cost averaging is also good for helping to establish a regular investing discipline. Over time you’re likely to wind up with a larger portfolio, if only because you were disciplined in your approach.
Risks: While the consistent method of dollar-cost averaging helps you avoid going all-in at the wrong time, it also means you won’t go all-in at the right time. So you’re unlikely to end up with the highest returns on your investment.
How to get started investing
Investing is a wide world, and new investors have a lot to learn to get up to speed. The good news is that beginners can make investing relatively simple with a few basic steps while they leave all the complex stuff to the pros.
Bankrate offers several resources for new investors:
- COURSE: How to invest for beginners (after a free sign-up)
- How to invest in stocks
- Comprehensive reviews of major online brokers
The links above will get you started on your investing journey. You’ll get educational content and research on stocks and ETFs, plus detailed instructions on how to place trades and make the most of the broker’s capabilities. And most major online brokers don’t have a minimum account size, so you can get started quickly, even today, if you just want to look around.
Investing can be one of the best decisions you can make for yourself, but getting started can be tough. Simplify the process by picking a popular investment strategy that can work for you and then stick with it. When you become more fully versed in investing, then you can expand your strategies and the types of investments you can make.
- How to start investing
- Index funds vs. mutual funds: What’s the difference?
- Low-cost index funds: A beginner’s guide
Note: Bankrate’s Brian Baker contributed to an update of this story.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.