With so many investment choices out there, it can be overwhelming to figure out what is the right option for you. Understanding what type of investor you are helps you narrow down the investment pool and focus in on investments that are suited for you. Multiple factors should be considered when determining the best investment for you and your unique investing goals.
Category of Investor
Investors fall into two broad categories.
Institutional Investors
Companies like BlackRock, State Street and Vanguard that invest money belonging to others. They invest for mutual funds, pension plans, insurance companies, investment banks, hedge funds etc. These investors make up for a majority of the volume of trades done on stock exchanges due to the sheer amount of capital they have access to.
Non-Institutional (Retail or Individual) Investors
As the name insinuates, not an institutional investor; someone who manages their own investments. You will find yourself in this category.
Investing Strategy
Investors use active or passive investing strategy.
Active Investors
Active investors seek to outperform the stock market with their investment decisions. This type of investor holds a riskier and more short-term focused investing style. By using an active investing strategy, you buy and sell stocks, looking to benefit from short-term price fluctuations. For example, bad news may come out about a specific stock. The active investor would likely buy the stock when it dips following the poor publicity, and then sell shortly after when the stock price returns to its typical value.
Passive Investors
Passive investors often choose mutual funds or index funds. This type of investor looks for long-term growth and uses a more hands-off method than active investors. They pass on tweaking their portfolio day to day, and instead select specific investments that let them generate returns over time. Passive investors may select a fund and hold it for years, not focusing on the ups and downs of the market, but looking for the value of the stocks in the fund to gradually rise. Passive investors can also choose to invest in specific stocks, but they buy and hold rather than trade in a short time frame.
Risk Profiles
Depending on the amount of risk an investor is willing to take on, they fall into various risk profiles that influence the type of investments they will chose to make. Typically, the closer an investor is to retirement, the less risk they are willing to take on, since they plan on using the money sooner. A younger investor tends to hold a riskier portfolio as they have time to ride out any price fluctuations before they plan to use the funds.
Conservative (Risk-Averse)
These investors strive to hold very little risk. Conservative portfolios hold mostly, if not entirely, government bonds as well as some equity investments (stocks) in stable, large companies. Government bonds are considered a low risk investment since the returns are predetermined. They are referred to ask fixed-income securities. When you buy a government bond, you are essentially loaning the government that amount, and in return you receive an agreed upon interest amount periodically. When the set time frame lapses, you receive full repayment (also know as the face value.) As the return on a conservative portfolio is set in advance, the profits are potentially smaller than those of the other risk profiles, but this is a trade off that is made when choosing to prioritize security.
Moderate
These investors are more open to risk than the conservative investor, however they still value stability. Their portfolio holds both fixed-income assets as well as equity. Large, medium, and small company stocks as well as international stocks can be found in a moderate portfolio, although large company stocks will make up the largest piece of their equity selection. A benefit of investing in stable companies is that they may issue dividends, which are payouts that are made to shareholders in return for owning part of the company. A moderate investor has the potential to make more than a conservative investor, but they take on more risk.
Aggressive
These investors create a portfolio that has a high risk exposure, as they have a higher tolerance for losses than a moderate or conservative investor. They seek the highest returns, and are willing to take on more risk in order to potentially achieve this. Aggressive portfolios tend to hold the most equity assets.
Company Selection
Market Capitalization
Some investors select equities depending on the market capitalization (total value of stock) of companies. To find the market capitalization, multiply the number of outstanding shares of a company by share price.
- Microcap companies have a market cap of under $300 million.
- Small-cap companies have a market cap of $300 million to $2 billion. These companies, as well as microcaps, tend to be riskier investments than large cap companies. There is typically more potential for price growth, since small cap companies have a lower stock price, but there is also more volatility. A company may still be well known and fall under the small-cap category. Examples of this are Bed Bath & Beyond and Office Depot. They have long histories, however their returns over time have not been strong enough to raise the share prices and push them into higher market caps.
- Mid-cap companies have a market cap of $2 billion to $10 billion.
- Large-cap companies have a market cap of over $10 billion. They are considered the most conservative stocks as they usually provide a history of strong returns and have the highest valued shares. Consider that the better a company performs, the more the stock price will rise, which will in turn increase the market cap. Most blue chip stocks ( like Coca Cola, Amazon, and Apple) fall into this category. Blue chips typically are leaders in their industries, maintain a strong reputation, pay dividends consistently, and possess a long track record of success. Indexes like the DOW, S&P 500, and NASDAQ hold mostly blue chip stocks. Tesla is an example of a company that had a massive market cap, but was not added to an index until 2020 as it did not display enough stability in earnings until that point.
Growth or Value Investing
Some investors choose companies specifically based on growth or value.
- Growth Investing – Investors looking to implement the growth style of investing choose stocks of companies whose earnings are growing faster than those of their competitors.
- Value Investing – Investors using the value investing style seek to invest in undervalued companies. Investors buy these stocks at low prices as they expect the price to rise to the true value of the stock over time.
Which are you?
No investing style fits every person. You need to consider your investing goals, your risk tolerance, the strategy you want to pursue and companies you would like to invest in. As you grow as a person, your investing approach may change as well. There is no right answer! While it is easy to look at what others do and think that you should just copy their trades, always make sure to select your investments based off of your own personal parameters and make decisions that are comfortable for you. Measure your success by comparing to your goals and don’t allow comparison to steal your joy!
The Content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.
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