Although there is a cadre of investors who are content to generate income from their portfolios without growing them, most investors would like to see their nest eggs increase over time. There are many ways to grow a portfolio, and the best approach for a given investor will depend upon various factors such as his or her risk tolerance, time horizon and the amount of principal that can be invested. This article will examine several basic strategies for portfolio growth.
There are several ways that growth can be defined when it comes to investing. In the most general sense, any increase in account value can be considered growth, such as when a CD pays interest on its principal. But growth is usually defined more specifically in the investment arena as capital appreciation, where the price or value of the investment increases over time. Growth can take place over both the short and long term, but substantial growth in the short term generally carries a much higher degree of risk.
There are several ways to make a portfolio grow in value. Some take more time or have more risk than others, but following is a list of tried-and-true methods that investors of all stripes have used to grow their money.
Buy and Hold
Buying and holding investments is perhaps the simplest strategy for achieving growth, and over time it can also be one of the most effective. Those investors who simply buy stocks or other growth investments and keep them in their portfolios with only minor monitoring are often pleasantly surprised with the results.
Those who follow the markets or specific investments more closely can beat the buy and hold strategy if they are able to time the markets correctly and consistently buy when prices are low and sell when they are high. This strategy will obviously yield much higher returns than simply holding an investment over time, but it also requires the ability to correctly gauge the markets.
This strategy is often combined with the buy and hold approach. Many different types of risk, such as company risk, can be reduced or eliminated through diversification. Numerous studies have proven that asset allocation is one of the largest determinants of investment return, especially over longer periods of time. The right combination of stocks, bonds and cash can allow a portfolio to grow with much less risk and volatility than a portfolio that is invested completely in stocks. Diversification works partly because when one asset class is performing poorly, another is usually doing well.
Investors who want aggressive growth can look to sectors of the economy such as technology, energy and small-cap stocks to get above average returns in exchange for greater risk and volatility. Some of this risk can be offset with longer holding periods and careful investment selection.
Dollar-Cost Averaging (DCA)
This common investment strategy is used most often with mutual funds. The investor will allocate a specific dollar amount that is used to periodically purchase shares of one or more specific funds. Because the price of the fund(s) will vary from one purchase period to the next, the investor is able to lower the overall cost basis of the shares because fewer shares will be purchased in a period when the fund price is higher and more shares are bought when the price declines. DCA thus allows the investor to reap a greater gain from the fund over time.
Dogs of the Dow
Michael Higgins outlines this simple strategy in his book "Beating the Dow." The "dogs" of the Dow are simply the 10 companies in the index that have the lowest current dividend yields. Those who purchase these stocks at the beginning of the year and then adjust their portfolios annually have beaten the return on of the index over time, although not every year. There are several UITs and ETFs that follow this strategy, so investors who like the idea but don't want to do their own research can purchase these stocks quickly and easily.
This method of picking stocks was developed by William O'Neil, who helped to found the Investor's Business Daily newspaper. His methodology is quantified in the acronym CAN SLIM, which stands for:
C : The ( C )urrent quarterly earnings per share (EPS) of a company needs to be at least 18 to 20% higher than they were a year ago.
A : The (A)nnual earnings per share needs to reflect material growth for at least the previous five years.
N : The company needs to have something (N)ew going on, such as a new product, change of management, etc.
S : The company should try to repurchase its own (S)hares outstanding, which is often done when companies expect high future profits.
L : The company needs to be a (L)eader in its category instead of a laggard.
I : The company should have some, but not too many, (I)nstitutional sponsors.
M : The investor should understand how the overall (M)arket affects the company's stock and when it can be best bought and sold.
These are just some of the simpler methods for making money grow. There are much more sophisticated techniques used by both individuals and institutions that employ alternative investments such as derivatives and other instruments that can control the amount of risk taken and amplify the possible gains that can be made. For more information on how you can find the right growth strategy for your portfolio, consult your stockbroker or financial advisor.