Techniques That Go into Investment Methodology: Risk, Cash Flow, and More

When we buy shoes, get a haircut, or listen to music, it’s obvious that everyone is different. Why would it be any different when we’re investing? Your investment portfolio and approach should be as personalized as anything else meant for you.

Unfortunately, that isn’t the case for many investors. A lot of people don’t consider their individual circumstances when they start investing, so they end up choosing the most accessible option and hope for the best. Wouldn’t you like a customized approach that meets your unique needs?

What Is Investment Methodology?

During the dot-com bubble of the late 90s, people used to get a call about the latest hot tech stock (on their large cell phones). They’d immediately call their brokers to put in an order for that stock.

Did they have an overall strategy for their investments? Were they aware of different investment strategies? No, they were just using a single investment technique—and not even using it very consistently.

Your investment methodology is a well-considered plan to get you to your goals within a certain timeframe. When you make your investment methodology, you should pay attention to:

  • A variety of investment techniques and markets
  • Your personal financial needs – both present and future needs
  • How to best meet your goals

What Are the Building Blocks of an Investment Methodology?

Before you go on a trip, you might look at a map, mark the exact place you want to travel, and plan the different forms of transportation you’ll use to get there. You’d want to know your desired arrival date and the level of danger you’ll be facing during the trip, right? In a similar way, that’s exactly what goes into your investment methodology. One way to work out your investment methodology is by consulting a professional investment adviser.

When determining methodology, consider using factors that professional investment advisers such as Fisher Investments may look at. These can be used to help you determine the best mix of assets for your plan, and include:

  • Risk considerations – It’s important to understand how comfortable you are with the investment risk of your portfolio and the potential that you may have a partial or complete loss of your investment capital. 
  • Investment objective – Not all investors have the same goals. While some are saving for retirement, others are saving for a child’s college fund or a wedding anniversary cruise. Your goals for what you want out of your investment can change what investments are appropriate for you.
  • Time horizon – The amount of time that you expect to stay invested in an asset or security is referred to as the time horizon. Generally, when an investor has a longer investment time horizon, they may be open to more risk because there is more time available to recover from a downturn.
  • Current income needs from investments – Different types of investments may pay the investor in different ways. For example, some stocks pay periodic dividends to the investors holding them. Others don’t, so investors must sell them to receive money. If you need income from your investments, it’s important to understand how they can provide it.
  • Other income streams –  It’s helpful to consider what other income sources you have when determining how to invest. Investment advisers often weigh this when determining investment plans, and it can impact what the investor needs.
  • Tax efficiency – Tax laws, when it comes to investing, can change how and where you want to invest. Some investments, like municipal bond funds, are entirely tax-free, but they are typically not liquid and have low yields. On the other hand, if you sell an investment for a profit within the first year of owning the investment, you can pay up to a 35% tax.
    • Other investments – It’s important to account for all investments as part of your investment methodology, whether they are managed personally or by a variety of advisers. Failing to do so could result in your portfolio lacking diversity or cause you to trade against yourself, subjecting yourself to fees or taxes without actually changing what you’re invested in.
  • Personal restrictions and inclinations – You matter, and your thoughts about your investments matter. You should never feel forced or pressured into investing in a particular security or fund if you don’t understand it or it conflicts with your personal moral code. 

Once you think through each of these, you can create your strategy to reach your goals. Moneycation gives these techniques that can go into an investment plan:

  • Planning entry and exit points – This refers to the price at which an investor buys or sells a security. Planning this ahead of time can help address some investment risk by removing emotion from these types of decisions. However, there’s never a guarantee of if or when an investment will hit your target entry or exit point, so be ready to adapt your plan to market conditions.  
  • Choosing specific securities – A vital part of any investment portfolio is the securities that are included. There are no ‘sure deals’ or ‘guaranteed’ securities, so it’s important to research a wide variety. You can do this by analyzing securities on fundamental value and technical history, though remember past performance doesn’t guarantee future results.
  • Calculating risk and probabilities of different yields – There is always risk when investing, and part of understanding your investment includes being aware of the risks you are taking on.
    • Testing – Before investing too much, it’s important to see if the work you have put into researching and building your strategy is valid. This can include theoretical testing through monitoring market trends to see if the estimated growth is close to the final yield, or using a small amount of capital to test with. Remember though, past performance doesn’t guarantee future performance – so be prepared to adapt your strategy to new information.
  • Allocating capital – Once you have a solid plan that has been researched and tested, you finally invest your capital. Always remember investing carries risk, so be sure you are ready to accept the loss of what you choose to invest.  
    • Diversifying your portfolio – Diversifying means choosing securities and investments that react differently to economic conditions, which helps mitigate the extreme losses that can occur if your investments are concentrated in only one area.
  • Rebalancing your portfolio – Only after you have seen the long-term return potential of your investments should you consider rebalancing your portfolio. No matter if your portfolio is seeing success or failure, rebalancing is your chance to reassess your assets and make choices in how you are going to continue.

This might seem like a lot, but there’s a lot of good information on the Suburban Finance blog to help. Don’t be like the tech investors that lost billions in the tech bubble. Carefully go over your financial facts, and build a plan that will get you from here to your dream financial state.

Be part of the conversation! Let us know in the comments section what your two or three biggest goals are for investments.

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