Stock Market Investing Strategies

Like every other investor, you are looking for the best possible returns for the lowest possible risk. You would naturally like to do better than the current interest rates on certificates of deposit but you would not wish to increase your risk exposure significantly. You are faced with a bewildering array of investment products that you cannot really understand or comprehend. All these products have in common seem to be uncomfortably high fees as well as high volatility. If possible, you would not wish to dabble in hedge funds or derivatives because you see these as high risk investments that you cannot possibly control. Here are a few tips on building up a sensible portfolio.

One of the first choices that you will have to make is between equities and bonds. Despite the ups and downs of the stock market, equities have outperformed bonds over the last 10 years but they do carry a higher risk… A combination of the two forms of investment can produce acceptable returns while carrying risk that is consonance with your risk appetite. If you look at equities for the period 1926 to 2010, the S&P 500 index produced an annual return of 9.9% while long-term US government bonds produced 5.5% for the same period. If you take into account the common measure of inflation which is the Consumer Price Index which averaged 3% for the same period, the real rate of return (adjusted for inflation) would work out to 6.9% and 2.5% respectively. Inflation can erode the purchasing power of your capital and equities are a good way of offsetting this erosion.

Another choice that you will be faced with in making your equity investments is whether you should invest in large companies or in small ones. If you look at the historical data, you will find that both domestically and internationally, small cap companies have outperformed large companies. Small companies are definitely riskier investments than large companies. This is because they are less well established, find it more difficult to secure debt and funding, have a higher mortality rate (though in the recent past, we have seen the collapse of some giant corporations) and so on. However the same historical data suggests that an investment portfolio with a bias towards smaller companies would have produced a higher return than a portfolio of large companies alone. In the US, the data from 1926 onwards shows that small companies have outperformed large ones producing average returns that are 2.1% higher annually on average. The figure for international companies is 5.8%.

Another factor to be considered in managing your portfolio is the management of your costs and expenses. You can opt for either active management or passive management. Active management will cost you more because an active manager will need to employ analysts and investment experts in order to plan and execute strategy. They also need to recoup their marketing costs which are also done through the load on the fund. Passive managers, on the other hand, tend to be cheaper because the benchmark themselves on selected stock-market indices so that they do not really need to worry about stock analysis and market timing. It all comes down to deciding whether the added expenses of active management actually produce higher returns.