Investment Strategies Explained: A Simple Guide to Growing Your Money

Choosing the right investment strategies is one of the most important financial decisions an investor can make. Since the introduction of passive index-based mutual funds in the 1970s and ETFs in 1993, passive index investing has gained significant popularity. However, this is just one approach in a diverse landscape of investing techniques.

For beginners exploring types of investment strategies, it’s essential to understand that each approach offers different advantages. Value investors, for instance, may buy assets they believe are undervalued but have potential for long-term growth. Additionally, research shows that companies led by their founders generally outperform indices. In fact, equities have consistently outperformed other asset classes over the long term. For those concerned about market timing, dollar-cost averaging removes the pressure of trying to time the market perfectly and aims to reduce the impact of market volatility.

This article examines the fundamentals of various investment strategies, enabling you to assess your financial situation, understand your risk tolerance, and ultimately select an approach that aligns with your personal goals and circumstances.

Assessing Your Financial Situation Before Investing

First and foremost, it is crucial to thoroughly assess your present financial situation before thinking about any investment strategy. This assessment forms the foundation upon which your investment journey will be built and helps determine which approach might work best for your circumstances.

Emergency Fund and Debt Considerations

Creating an emergency fund should be your priority before investing. Financial experts recommend setting aside money to cover 3-6 months of essential living expenses, including mortgage, utilities, and food. This financial safety net acts as insurance against unexpected events and should be kept in a high-interest savings account for easy access.

Without an emergency fund, unexpected expenses might force you to sell investments prematurely, potentially at a loss. Consider the example of a homeowner who faced an AUD 15,289.90 bill to replace a broken air conditioning unit during a heatwave. Those with emergency savings avoided financial stress, while those without may have needed to liquidate investments or accumulate high-interest debt.

Speaking of debt, paying off high-interest liabilities, such as credit cards, should take precedence over investing. These debts typically carry interest rates far exceeding potential investment returns, making debt reduction a more financially sound decision initially.

Setting Short-Term and Long-Term Financial Goals

Defining clear financial objectives is crucial for selecting appropriate investment strategies. Goals are typically categorised by their timeframe:

• Short-term goals (less than 1-3 years): These include buying a phone, planning a holiday, or establishing an emergency fund. According to research, 43% of Australians with financial goals are saving for holidays, whilst 32% are building emergency funds.
• Medium-term goals (1-5 years): These might include purchasing a car, saving for education fees, or starting a business.
• Long-term goals (5+ years): These encompass major life milestones, such as buying a property, funding retirement, or leaving a lasting legacy.

Each category requires different investment approaches. Short-term goals generally demand low-risk, highly liquid options, whilst long-term goals can withstand greater volatility in exchange for potentially higher returns.

Understanding Investment Timeline

Your investment timeline—the period before you need to access your money—significantly influences which investment strategy suits you best. This timeline directly affects the amount of risk you should reasonably take on.

For goals less than five years away, conservative investments like cash accounts, term deposits, or government bonds are typically more suitable. Conversely, goals with horizons beyond five years may benefit from growth-oriented investments, such as shares or property, which have historically delivered higher returns despite short-term fluctuations.

Age often affects timeline considerations, with younger investors generally able to adopt more aggressive strategies due to having more time to recover from market downturns. Nevertheless, remember that retirement doesn’t necessarily mean a short investment horizon—many retirees need their investments to last 30 years or more.

Your timeline, risk tolerance, and goals should align with each other. While a person in their 40s or older could want a more balanced strategy, someone in their 20s might select a larger percentage of shares. Furthermore, diversification remains essential, not just across different investment types but also within each asset class to protect against excessive losses.

Understanding Risk and Market Volatility

Risk lies at the heart of every investment decision. Understanding what risk means to you personally and how markets fluctuate over time forms the foundation of successful investing.

How to Evaluate Risk Tolerance

Risk tolerance encompasses two distinct elements that work in tandem: your willingness and your ability to handle investment uncertainty. Your willingness reflects your psychological comfort with volatility, whilst your ability represents your objective financial capacity to withstand potential losses.

To accurately assess your risk tolerance:

1. Examine your financial situation – Consider your emergency fund, income stability, and alternative resources. Would a market downturn jeopardise your day-to-day finances or essential assets?
2. Evaluate your investment timeline – Longer timeframes generally permit higher risk exposure as you have more time to recover from market fluctuations. Someone with decades until retirement typically has greater risk capacity than someone approaching retirement with limited savings.
3. Consider your emotional response – How would you react if your investments suddenly lost 20% of their value? If this would cause you anxiety and lead to withdrawing funds, high-risk investments may not be suitable for you.

Standard deviation serves as a common measure of investment volatility, with higher values typically indicating riskier investments. Essentially, risk assessment enables investors to calculate potential losses and determine whether an investment’s possible returns justify its associated risks.

Emotional vs Logical Investing Decisions

Our emotions exert a powerful influence over investment choices, sometimes leading to decisions that conflict with rational analysis. Fear and greed stand out as particularly influential emotions.

Research shows that investors feel losses approximately twice as strongly as gains, explaining why market downturns often trigger stronger emotional responses than equivalent upswings. This asymmetric emotional reaction can lead to poor timing decisions—selling during downturns and buying during peaks.

Investor panic caused losses of between 8% and 15% of assets during a ten-year period, according to a study published in the Journal of Financial Planning. Consequently, recognising your emotional triggers becomes vital during market turbulence.

To balance emotion with logic:

• Develop a comprehensive investment plan that outlines your goals, risk tolerance and timeline
• Maintain perspective on timeframes – short-term volatility rarely affects long-term growth potential
• Take a step back before making decisions during emotional highs or lows

Impact of Market Cycles on Strategy Selection

Financial markets undergo four distinct phases that repeat continuously: accumulation, markup, distribution, and markdown. Each phase presents different opportunities and risks, which affect the investment strategies that might prove most effective.

The accumulation phase occurs at market bottoms when early adopters recognise bargain opportunities. The mark-up phase follows as recovery becomes evident and more investors return. Subsequently, the distribution phase brings mixed sentiment, accompanied by selling pressure, while the markdown phase sees remaining investors capitulating.

Different investment strategies perform optimally during specific phases of these cycles. Higher-risk investments typically excel during bull markets (rising phases) but underperform during bear markets (falling phases). Likewise, defensive investments, such as fixed income, often outperform during downturns.

Understanding these cycles enables investors to anticipate potential shifts and adjust their portfolios accordingly. Ultimately, your strategy selection should align with both the current market cycle and your personal circumstances—including risk tolerance, time horizon, and financial objectives.

Remember that volatility isn’t inherently harmful—it creates opportunities for disciplined investors to capitalise on. Market corrections can provide entry points at lower prices, potentially improving long-term returns for those prepared to act against prevailing sentiment.

5 Basic Types of Investment Strategies

Understanding various investment approaches enables investors to select methods that align with their financial objectives. Below are five fundamental investment strategies that form the bedrock of most investment portfolios.

1. Passive Index Investing

Passive indexing aims to match market returns rather than beat them by tracking the performance of a specific index. This approach gained popularity after Vanguard introduced index funds in the 1970s, now representing 16% of Australia’s total investment management market with AUD 576.43 billion invested. The strategy works by purchasing securities in the same proportions as they appear in the index. Primarily, passive investing offers two advantages: portfolio diversification through broad market exposure and potentially improved long-term returns through reduced volatility and lower costs. Moreover, passive funds typically have lower management fees as they don’t require highly paid research teams to analyse securities.

2. Value Investing

Value investing involves identifying stocks that trade below their intrinsic value—essentially finding “bargains” in the market. This strategy operates on the premise that markets occasionally overreact to both good and bad news, resulting in pricing discrepancies. Value investors examine metrics such as price-to-book (P/B) and price-to-earnings (P/E) ratios to find undervalued companies. Notably, the father of value investing, Benjamin Graham, recommended buying stocks when priced at two-thirds or less of their liquidation value. Although value investing requires patience, studies consistently show that value stocks outperform growth stocks over extended periods.

3. Growth Investing

Growth investing targets companies expected to expand more rapidly than their industry peers, focusing on capital appreciation rather than dividend yields. Unlike value investors who seek bargains, growth investors often pay premium prices for stocks with exceptional growth potential. Successful growth investors evaluate five key factors: historical earnings growth, forward earnings projections, profit margins, return on equity, and stock performance. Therefore, growth stocks typically trade at higher P/E ratios as investors anticipate future earnings increases. Although there is a greater risk associated with this strategy, individuals who successfully identify tomorrow’s industry leaders may reap significant benefits.

4. Momentum Investing

Momentum investing operates on the principle that rising stocks tend to continue upward and falling stocks tend to continue downward. This strategy, popularised by Richard Driehaus, focuses on buying high and selling higher rather than finding underpriced assets. Momentum investors rely heavily on technical analysis and market psychology. They typically look for stocks with strong recent performance over the past six to twelve months. While momentum has historically delivered higher risk-adjusted returns than other factors—approximately 10% higher over 10 years and 28% higher over 20 years—it occasionally experiences short-term crashes.

5. Dollar-Cost Averaging

Investing a set sum at regular periods, independent of market conditions, is known as dollar-cost averaging, or DCA. This disciplined approach helps investors avoid market timing challenges while potentially lowering the average cost per share. By consistently investing through market fluctuations, investors automatically purchase more shares when prices are low and fewer when prices are high. DCA is particularly effective for beginner investors and those with regular income streams. Additionally, this strategy removes emotional decision-making from investing, preventing potentially damaging knee-jerk reactions to market volatility.

Comparing Investment Strategies by Risk and Return

The risk-return tradeoff forms the cornerstone of comparing investment approaches. This fundamental principle establishes that higher potential returns typically come with greater risk.

Volatility Levels Across Strategies

Investment volatility varies significantly across different approaches. Growth and momentum strategies exhibit considerably higher standard deviations—a key measure of risk—compared to value or passive strategies. Specifically, examining historical performance reveals that an investment with a 12% annual return might have a standard deviation of 20%, whereas another yielding 6% might have half that volatility at 10%. Within equity-focused approaches, technology-heavy portfolios typically experience more dramatic price swings than those concentrated in consumer staples or banking sectors.

Expected Returns Over 5+ Years

Long-term returns differ markedly by strategy and asset class. Historical data show that Australian shares delivered 13.7% returns over one year and 8.8% over ten years. Meanwhile, global shares (unhedged) outperformed, with annual returns of 18.7% over the past year and 12.1% over the past decade. In comparison, cash investments yielded just 4.4% and 2.0% over the same periods. Australian investors typically expect returns of 10.8% above inflation, notably 22% higher than the estimates of financial professionals at 8.9%.

Liquidity and Time Commitment Differences

Investment liquidity exists on a spectrum. Cash and government bonds offer near-instant accessibility, whilst listed equities provide intraday liquidity under normal market conditions. Alternatively, property investments require commitment periods of at least five years. Private equity and certain alternative investments often lock capital away for extended periods but potentially offer liquidity premiums—additional returns that compensate for this reduced access. Importantly, even seemingly liquid investments can experience reduced tradability during market stress, as evidenced by ETFs trading below their NAVs during the 2020 pandemic selloff.

How to Choose the Best Investment Strategy for You

Selecting the optimal investment strategy requires careful consideration of several personal factors. The right approach must balance your unique circumstances with market realities to create a sustainable path forward.

Aligning Strategy with Financial Goals

An effective investment strategy must be directly aligned with your specific financial objectives. Your investment choices should reflect both your short-term and long-term goals, whether you’re saving for a vacation, a home purchase, or retirement. Primarily, the strategy must consider your risk appetite—what level of risk you are willing and able to take. Age frequently influences strategy selection; a 25-year-old starting their career might reasonably consider riskier investments with growth potential, whilst a 45-year-old might prefer a more conservative approach as retirement approaches.

Combining Multiple Strategies in One Portfolio

Instead of relying on a single approach, many successful investors implement multiple strategies simultaneously. This “bucket approach” helps ensure you have various assets aligned with different risk tolerances. For instance, you might combine growth investing for long-term wealth building with income investing for regular cash flow. Alternatively, a balanced strategy might allocate 60% to growth assets and 40% to defensive ones, providing both accumulation potential and stability.

When to Switch or Adjust your Strategy

Periodic review and adjustment of your investment strategy is essential. Major life events—such as marriage, having children, career changes, or approaching retirement—often necessitate a reassessment of strategy. Furthermore, regularly rebalancing your portfolio maintains your intended asset allocation, especially after significant market movements. When rebalancing, consider selling five per cent of overperforming assets to purchase underperforming ones, thereby maintaining your target allocation.

Conclusion – Investment Strategies

Investment strategies require thoughtful consideration of personal circumstances, financial goals, and market realities. Indeed, building a solid foundation starts with establishing an emergency fund and addressing high-interest debt before committing capital to markets. Understanding your risk tolerance remains equally essential, as this shapes which approaches suit your personality and financial situation.

The five fundamental strategies—passive index investing, value investing, growth investing, momentum investing, and dollar-cost averaging—each offer distinct advantages depending on your objectives. Passive approaches offer broad market exposure at lower fees, while value investing targets underpriced assets with strong fundamentals. Growth strategies target companies with exceptional expansion potential, and momentum approaches capitalise on existing market trends. Meanwhile, dollar-cost averaging removes timing pressure through consistent, scheduled investments.

Your optimal strategy ultimately depends on your unique situation. Factors such as age, financial goals, and timeline significantly influence which approach is most effective. Many successful investors employ multiple strategies simultaneously, creating diversified portfolios that balance growth potential and stability. Additionally, regular portfolio reviews ensure that your investment approach evolves in tandem with significant life changes and shifting financial priorities.

The journey toward financial success demands both patience and discipline. Although market cycles inevitably create volatility, thoughtful strategy selection aligned with personal circumstances helps mitigate these fluctuations. Rather than seeking perfect timing, focus on developing a comprehensive plan that accommodates your goals, risk tolerance, and investment horizon. After all, consistent application of sound investment principles typically yields better results than attempting to predict short-term market movements.