You are interested in investing, so interested that you buy shares left, right and centre. You probably don't follow a logical pattern, buying shares in a company where you know some people or because family members and friends have invested there. After a while, you ask yourself whether you should put more structure on your investing. But how? There are a number of methods and strategies you could follow. Not all are equally successful, but many roads lead to Rome. Here is a sample from the strategic arsenal.
Dogs of the Dow
The Dogs of the Dow strategy is based on the principles outlined by Michael O' Higgins in his book ‘Beating the Dow’ (1992). Described as ‘America’s canniest market wizard’, O' Higgins bases his proposition on the premise that certain shares are undervalued, which has nothing to do with the performance of the company. The share is undervalued when there is a percentile divergence between the actual share price and its theoretical value.
O' Higgins says the value of these shares will recover as long as you have patience to wait. To profit from the recovery, you have to ensure you have the 10 stocks with the highest dividend yield in your portfolio. The simplicity of the strategy is in the fact that you buy the shares on a given day and that you don't look at them again for a year. Then on a fixed date, you review your portfolio.
Buy the winners strategy
This strategy focuses on buying shares, which performed the best over the preceding period. In fact, this approach of 'all is well as long as the funds rise' is a form of technical analysis. This strategy is laborious as share values don't continue to rise indefinitely and continuous adjustment of your portfolio is essential. Transaction costs incurred by each adjustment eat into returns.
The two strategies just outlined are the most common, but there are lots of other strategies too. The most important question when choosing a strategy is: ‘what are the consequences?’ To spell out the consequences clearly, we will go through a number of other strategies.
The buy-hold strategy
As the name suggests, you buy shares and then you leave the market to do its work. It may appear a ‘maintenance-free’ approach, but naturally you have to keep an eye on the market, to watch out for signs it is not going too crazy, or too negative. If that is the case, then hold has to give way to sell.
The growth strategy
Logically you buy shares you expect to rise in value. In this strategy, however, you are most interested in the dividend yield. It should be low to leave room to grow.
The contraire strategy
Going against the grain is the key to this strategy. When the market is going strong, you stay your hand. You step in when the downturn hits. By buying shares in a low market, you can really cash in when the market picks up again, picking the fruits of profit. Merill Lynch has developed a variation where the investors listen to recommendations given by analysts: the more positive the analysts are, the quicker you have to get out and the more negative… well you get the picture.
The continuous limit strategy
This is simply a question of setting long-term limits. How does it work? Say you want to buy City Comment shares at 35 euro each, while the actual price is 40 euro. You lodge your purchase order for the shares at 35 euro, with your bank and the shares are bought if and when the price falls to the right level. You then set a sell price of say 50 euro. The disadvantage is that the share price might continue rising and not fall to your buy limit, leaving you at risk of missing the boat.
Rutger Derksen is a City Comment editor. The information in this column is not intended as professional investment advice, and neither as a recommendation for any particular investments. Reactions can be mailed to: derksen@iex.nl