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Therese Schultz5/15/16Investment Strategy PaperAn investment strategy is an investor's plan of action, devised by considering goals, tolerance of risk, and need for capital to guide investment?decisions. To determine my strategy, I thought about how competitive I would like to be, how long I am willing to wait for my desired outcome, where I want to invest my money in, and what type of investing would line up with these considerations the best. My strategy is to invest in index funds as they are some of the best investment vehicles due to the lower costs, tax efficiency, and limited maintenance. The advantages of indexing allow me to be confident in this strategy and will be thoroughly explained later on. If people thoroughly looked into index funds and sought out the advantages, I believe that more people would follow the strategy.As I am new to the world of investing, I will invest $100,000 in a safe, suitable manner. Being a sensible investor requires a basic understanding of the various industries of the market and focusing on asset allocation. I wish to invest at a low cost and also want to maximize my returns while diversifying my portfolio. I will be investing this $100,000 in index funds that mirror the current market. More specifically, I will be investing in the S&P 500. I will take a passive approach to investing, as I will be focusing on buying and holding. Instead of trading very frequently, similar to the approach that I took in the market watch game, I will have a long-term point of view and will hold for a longer period of time than I did in the market watch game. According to the article “How To Diversify With Just Three Mutual Funds”, “Investors don’t need to try and “beat the market.” Investors only need to match the market, something that is surprisingly difficult to do” (Dogu, 2011). I believe in this statement because those who do not see the truth behind this act irrational. The way I invest my $100,000 will be by attempting to match the market by following a passive approach.To determine how I will invest the $100,000, I followed Malkiel’s advice to distinguish my attitude toward my capacity for risk. Thinking long-term about investing led me to believe that my capacity for risk could vary, depending on my financial situation throughout adulthood. Malkiel states, “Never take on the same risks in your portfolio that attach to your major source of income”. (Malkiel, 373). For example, if I were to invest right now, my capacity for risk would be more constrained because I do not have an income as high as I would post graduation. On the other hand, if I were making more money and had extra money to invest, I would be willing to bear more risk. Furthermore, if investing this $100,000 would not alter my standard of living too much, then I will be able to bear more risk. According to Malkiel and several others who follow a passive investing strategy, risk and return are related, as demonstrated throughout history. He states, “Higher risk is the price one pays for more generous returns” (Malkiel, 361). If I am willing and able to act in a riskier manner, then I could end up with greater returns than before. This relates to my point that I would have make sure that I could be riskier because I could also end up losing more. This relates to my overall strategy because I will not be very risky with this $100,000 as I plan on investing long-term. The S&P 500 is my choice of investment because I believe that I will be able to diversify my portfolio as it includes 500 of the most profitable companies in the United States. Throughout the duration of our class game, I often invested in companies that were popular at the time and did not have the long term mindset. While I invest in the S&P 500, I will choose companies that have the growth potential based off of what their company or product offers. An article from The Motley Fool, a website with information on investing, states, “The Vanguard S&P 500 fund has outperformed over 90% of all domestic equity mutual funds over the past three and five years (and a much higher number if you include bond and international equity funds)” (“The S&P 500 Index Fund”). These companies are very profitable and I am confident that I would be making the right choice by investing in it. Investing in The S&P 500 is a great idea for an average investor, or new investor, like me. Index funds provide wide-ranging market exposure. If there is a greater market exposure in a portfolio, then I would have the ability to determine which stocks will influence my portfolio’s returns, depending on the market exposure. When I invest in an index fund, such as I would essentially be taking on the same risks as the market. Indexing is effective because all securities markets are generally quite efficient. For example, if news about a specific company surfaces, the market price is quickly affected. This is different than other investment vehicles because some take time to reflect price changes. If investors attempt to outsmart the market, those who are active managers, they will not be efficient in doing so. An additional advantage of indexing is that the all stocks in a specific market are held by someone. The article “Has Indexing Become Too Popular” states, “All the stocks in any particular market must be held by someone. Therefore, if some active portfolio manager is holding only the stocks that go up?more?than average, then it must follow that some other investors are holding the stocks that went up?less?than average. Investing has to be a zero sum game” (Malkiel, 2015). This demonstrates the idea that investing in index funds can be more cost-efficient because they can be purchased at inexpensive costs. On the other hand, active managers are required to pay higher fees and additional costs to invest in those stocks that are higher than average. This may be the case, but investors who seek index funds are benefiting more in the long run because of the lower costs. This idea solidifies the importance of prioritizing long term gains, rather than focusing on maximizing short term gains. Passive investing, as we have learned is a great technique, especially for new investors like me, as I would not have to be very active in managing my portfolio. It is less expensive than active investing because of the fees and taxes that are acquired from frequently trading. Taking the passive approach and focusing on index funds will ultimately reduce costs compared to active investing, as the trading costs and fees will be less than it would if I was continuously making changes in my portfolio. Moreover, it is critical to not let emotions get in the way during times when the market is underperforming. An article on passive investing states, “It is fine for investors during periods of positive performance of the index, however potentially frustrating for the investor during market falls, as a passive fund manager will not take any action to stem the losses” (Daroga, 2015). It could be gut-wrenching to watch stocks in a portfolio drastically decrease, but it takes a patient investor to continue seeing the potential value in a stock and continue holding. To fully follow the passive investing strategy, it is important to focus on the belief of buying and holding, especially during times of market falls, while limiting trades. The chart below demonstrated the increase in popularity of passive management. The trend is catching on, although there are still more investors who believe in active management of portfolios.Chart from Furthermore, being less active would be beneficial to me as I would not be seeking out attractive stocks, bonds, or mutual funds. If I attempted to be an active investor, it would be necessary for me to seek out information that I am not very familiar with. For example, I would need to research to find out what would be the right time to enter or exit a specific market sector. As a new investor, I do not know how to properly evaluate this information, which could lead me to taking risks that I could avoid. This demonstrates the idea that active management of a portfolio is more risky than passively managing, which is why I will continue investing in a passive manner. While there are these downfalls of active management of a portfolio, there are positives for those who are knowledgeable and can eventually outperform their benchmark. I realized that I would not use this strategy in real life because it can be a stressful process that requires discipline and strategy. If I were to participate in this game again, I would do things differently. Although I ended up in fourth place at the end of the game, I fully believe that I could have taken a different approach and still end up towards the top in rankings. I made 158 trades in the duration of the game, which was the highest amount that anybody had made. This is due to my lack of knowledge on investing at the beginning of the semester, as I frequently day traded. I did not have a clear strategy in mind and simply bought stocks that I did not know about, just because they were doing well. I thought that if I bought these shares while they were doing well and sold them when they began to decrease, I would continue increasing my returns. This was the approach I took at the beginning of the game before I began reading Malkiel’s A Random Walk and learned about proper techniques and tactics of investing. While day trading boosted my returns in the game, it would not be beneficial to use this strategy in reality. A major disadvantage of day trading is that nobody is guaranteed to make money. While investors day trade in hopes of making small gains, they could result in small losses too. These small losses eventually add up, which makes the strategy very risky. This is one concept I did not realize when I was day trading. Another disadvantage is how expensive it can be to day trade. There are capital gains taxes and transaction costs, which can end up being expensive. Therefore, if I could redo the game, I would take a different approach, which I will discuss later on. Overtrading, similar to how I traded in the market watch game, is frowned upon by behavioral finance specialists. The reason for this is the amount of taxes I would have to pay. This also led me to realize that I was overconfident in my transactions as I focused more on increasing my returns, rather than considering the cost that overtrading would incur. With this $100,000, I will attempt to be more aware of the outcome. I will trust my judgment by sticking with index funds but I will gather more information before I invest.A buy-and-hold strategy is part of my improved plan because I am confident that I would be avoiding larger taxations than necessary. So, buying and holding my diversified portfolio will allow me to save on my investment expenses. I plan on holding onto my long-term investments, even throughout the fluctuations in the market. I am patient enough to see the long-term value that an investment could have. “Why Buy and Hold Works” suggests, “Everyone wants to be a buy and hold investor during a bull market, but people change their tune when losses set in” (Carlson, 2015). This article discusses how there will always be skeptics when a market is soaring or taking a beating. This demonstrates the importance of remaining true to your core beliefs. I will diversify my portfolio because I believe that doing so will limit the impact of volatility in my portfolio while hopefully increasing returns. Within my portfolio, I plan on diversifying to help reduce the volatility of my portfolio over time. Below is an example of how I plan on investing to eventually maintain a well-diversified portfolio. Chart from I will invest in domestic stocks because I do not want to be risky while choosing what my portfolio will be made up of. During the market watch game when I invested in stocks that were popular in the news, I tried to diversify and extend to different sectors of the market, which I will continue to do with the $100,000. I will choose stocks that are in different industries, such as: industrials, technology, health care, and energy. I invested in all of these sectors except health care in the game and it worked out for me, but I am choosing to expand into the health care because I have noticed the value of pharmaceuticals in today’s world. I believe that technology is a great sector to invest in because technology is constantly advancing. Moreover, investing in different sectors of the market will allow me to have the potential to maximize returns as I would not be limited to one sector. I will also be investing in precious metals because I saw the effect of it in the game. If held onto, they have the potential to soar in value. I also believe that investing outside of the global market can offer higher potential returns, which is why I will add foreign stocks to my portfolio. An article from suggests, “Stocks issued by non-U.S. companies often perform differently than their U.S. counterparts, providing exposure to opportunities not offered by U.S. securities” (“Why Diversification Matters”). By investing in these foreign markets, I will be taking on a little more risk, but I believe it could be beneficial in the long run. Additionally, I formed my strategy after taking Burton Malkiel’s advice from A Random Walk Down Wall Street into consideration. Throughout the text, Malkiel stresses the importance of keeping fees low and not believing those who think that they have the abilities to beat the market. He incorporates words of advice for investors who are looking to invest long-term. While investing my $100,000, I will take Malkiel’s advice into consideration and avoid practicing behavioral finance. A few key points that he discusses in behavioral finance are: overconfidence, making biased judgments, and herding. While investors may let these behaviors affect their decisions, they are acting irrational. Malkiel states, “More than most other groups, investors tend to exaggerate their own skill and deny the role of chance” (Malkiel, 239). This portrays those who are overconfident as irrational because they believe in their strategies that they may be too optimistic about the market. This could result in the investor making poor decisions because they only see their point of view. It is important to take other perspectives into consideration to make the right decision in investing. When I create my portfolio with $100,000, I will make sure to keep my options open. This goes along with not making biased judgments because I will do my best to keep in mind that I cannot completely control my investment results. Finally, herding could be harmful to an investor if they focus too much on what other people are doing. It would be hard for me to increase my returns if I am following what other people do if they are constantly wrong.Malkiel suggests that fundamental analysis is dependable enough to follow. Investors who are looking to estimate the current worth of the company use this to see how others value a possible investment. Investors will analyze a specific company or industry’s financial ratios to determine the financial health in attempts of estimating the value of a stock. This is more dependable than technical analysis because this concentrates on a specific company, rather than comparing to others in an entire market. I believe in fundamental analysis because it is used in long-term investments, which is the gist of my plan. In order to use this analysis properly, I will have to pick the industries or companies that I think will eventually grow and people will see the value in. After learning about fundamental analysis, I feel that consumer preferences are a major factor in fundamental analysis because if I could predict the popularity of a product or even company, based off of financial statements and earnings, then I could be using this long-term investment for large returns. Another advantage of utilizing fundamental analysis in investing is that it gives investors the experience of internally analyzing a company. Not only would this assist one in determining when to get into a market, it also could tell when to get out. Malkiel argues that technical analysis had more disadvantages than advantages because it lacks reliability. "The past history of stock prices cannot be used to predict the future in any meaningful way" (Malkiel, 148). Malkiel implies that history cannot and should not be used to predict future prices and the performance of a stock. Since this analysis provides indicators that are simply estimations of possible entry and exit timing in the market, it is not 100% reliable. Although it may be a high chance of being correct, there is still a risk that is being taken if the estimates are used. For example, a stock price may rise after one exits and the stock price may decrease after the entry, so there is chance the indicators could cause investors to underperform. This small chance could end up causing major losses if they are greatly relied on.Although I believe in index funds, there are investors who do not see the benefit of investing in an index fund and letting it ride. Some say that investors do not have control over their holdings in an index because they are already set. The downfall of this could be that if I chose to only invest in an index fund, I would not be able to choose a specific company that is becoming popular or that I see growth potential in if it was not in the index. Another reason active managers do not believe in indexing is because there is little room to strategize. If I came up with new creative ideas, it would be a little difficult to apply them because of the low risk that I am willing to bear. However, the advantages of indexing trump the disadvantages in my opinion. I believe that since I want to take a broad economic view and am new to investing, I wish to play it safe and stick with an index fund. Overall, I have taken what I have learned throughout the semester-long course, the market watch game, and A Random Walk Down Wall Street to determine how I want to invest my $100,000. Investing in index funds is the right choice for me as I wish to play it safe at a more inexpensive cost. I understand how I am willing to take on little risk because I am new to this experience and want to make sure I am making the right move. My beliefs line up with Malkiel’s text because I will be a passive investor, as I do not want to actively manage my portfolio. The market watch game guided me to this belief because I realized that actively managing my portfolio and day trading is not the right strategy for me. Due to how expensive day trading could be, I realized that in reality it might be limiting my returns as I would be spending a lot of money. I will use fundamental analysis on every investment that I make because I believe it could help me break down the intangible aspects of a company. As a result of the class, I have learned what type of investor I want to become, how much risk I am willing to take on, and types of industries or companies that I should invest in.Works CitedCarlson, B. (2015, July 14). Why Buy & Hold Works. Retrieved May 11, 2016, from Daroga, H. (2015, December 03). Here's Why Active Funds Are More Expensive. Retrieved May 10, 2016, from Dogu, L. (2011, January 28). How To Diversify With Just Three Mutual Funds. Retrieved May 10, 2016, from If Your Portfolio Earned Over 14% Last Year, We Believe You Should Fire Your Advisor – Adams Chetwood Wealth Management Group. (n.d.). Retrieved May 11, 2016, from , B. G. (2003). A Random Walk Down Wall Street: The Time-tested Strategy for Successful Investing. New York: W.W. Norton. Malkiel, B. (2015, January 15). Has Indexing Become Too Popular? - Wealthfront Knowledge Center. Retrieved May 10, 2016, from The S&P 500 Index Fund - Mutual Fund Center. (n.d.). Retrieved May 10, 2016, from , J. (2015, December 30). These Charts Show the Astounding Rise in Passive Management. Retrieved May 10, 2016, from Diversify? - Fidelity. (n.d.). Retrieved May 10, 2016, from ................
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