Common Investment Strategies

Beyond the active versus passive decision, investors and portfolio managers employ various investment strategies to pursue returns, manage risk, and align portfolios with client goals. Understanding these strategies—their mechanics, advantages, and limitations—is essential for CFP professionals constructing client portfolios.

This section covers style-based investing, systematic approaches, portfolio construction methods, and the increasingly popular factor investing (smart beta) approach.

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Style-Based Investment Strategies

Style-based investing categorizes securities and portfolios based on specific characteristics. The most common style distinction is between value and growth investing.

Value Investing

Value investing is a strategy focused on identifying securities trading below their intrinsic value. Value investors believe the market occasionally misprices securities, creating opportunities to buy "cheap" stocks that will eventually appreciate to fair value.

Key Characteristics of Value Stocks:

• Low price-to-earnings (P/E) ratios
• Low price-to-book (P/B) ratios
• High dividend yields
• Often mature, established companies
• May be temporarily out of favor with the market

Historical Performance: Value stocks have historically outperformed growth stocks over very long periods, though this "value premium" has been inconsistent in recent decades. The 2010s saw significant growth outperformance, leading some to question whether value investing remains effective.

When Value Works Best:

• Early economic recoveries
• Rising interest rate environments
• Mean reversion periods following growth bubbles
• Periods of market pessimism

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Growth Investing

Growth investing focuses on companies expected to grow earnings faster than the overall market. Growth investors are willing to pay premium valuations for superior growth prospects.

Key Characteristics of Growth Stocks:

• High P/E and P/B ratios
• Low or no dividends (reinvesting profits)
• Strong revenue and earnings growth rates
• Often in technology, healthcare, or emerging industries
• Higher volatility than value stocks

When Growth Works Best:

• Low or falling interest rate environments
• Economic expansions
• Periods of technological disruption
• Strong consumer confidence periods

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Value vs. Growth Comparison

CFP Exam Tip: Value and growth often perform differently across market cycles. Diversified portfolios typically include both styles, allowing them to complement each other over time.

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Momentum Investing

Momentum investing is based on the observation that securities that have performed well recently tend to continue performing well in the near term, and vice versa. Momentum investors buy "winners" and sell or avoid "losers."

How Momentum Works:

• Identify securities with strong recent performance (typically 3-12 months)
• Buy securities showing positive momentum
• Sell securities showing negative momentum
• Rebalance regularly to capture new trends

Momentum Metrics:

Research Evidence: Academic research has documented a persistent "momentum premium" across asset classes and geographies. However, momentum strategies are subject to:

• Sharp reversals ("momentum crashes")
• High turnover and trading costs
• Tax inefficiency due to short holding periods
• Implementation challenges at scale

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Contrarian Investing

Contrarian investing is the opposite of momentum—buying assets that are out of favor and selling those that are popular. Contrarians believe markets overreact to both good and bad news, creating opportunities.

Contrarian Principles:

• Buy when others are fearful; sell when others are greedy
• Look for securities with excessive pessimism priced in
• Avoid "crowded trades" where everyone agrees
• Requires patience—being early can feel like being wrong

Contrarian Indicators:

CFP Exam Tip: Contrarian strategies require strong conviction and a long time horizon. Explaining to clients why you're buying unpopular investments requires effective communication.

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Systematic Investment Strategies

Systematic strategies follow predetermined rules for investing, removing emotion and timing uncertainty from the process.

Dollar-Cost Averaging (DCA)

Dollar-cost averaging involves investing a fixed dollar amount at regular intervals, regardless of market conditions. This systematic approach reduces timing risk and behavioral mistakes.

How DCA Works:

Notice that the average cost per share ($39.54) is lower than the average share price ($42.50). This occurs because more shares are purchased when prices are low.

DCA Advantages:

• Reduces timing risk and eliminates market timing decisions
• Enforces disciplined investing
• Average cost per share is lower than average price (when prices fluctuate)
• Psychologically easier than lump-sum investing
• Appropriate for regular income situations (401(k) contributions)

DCA Limitations:

• May underperform lump-sum investing in rising markets
• Research shows lump-sum beats DCA approximately 2/3 of the time
• Best for risk-averse investors or those with regular cash flows

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Buy-and-Hold Strategy

Buy-and-hold is a long-term investment approach where investors purchase securities and hold them for extended periods regardless of short-term market fluctuations.

Key Benefits:

When Buy-and-Hold Works Best:

• Long time horizons (10+ years)
• Diversified portfolios
• Low-cost index funds or ETFs
• Investors prone to behavioral mistakes

Potential Concerns:

• May hold through significant drawdowns
• Requires discipline during market stress
• Rebalancing still necessary for risk management

CFP Exam Tip: Buy-and-hold is most appropriate for long-term investors in diversified portfolios. It minimizes the two major drags on returns: taxes and transaction costs.

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Portfolio Construction Strategies

These approaches address how to structure an overall portfolio, combining multiple asset classes and strategies.

Sector Rotation

Sector rotation involves shifting portfolio allocations among market sectors based on the economic cycle. Different sectors tend to outperform at different stages of the business cycle.

Economic Cycle and Sector Performance:

Sector Rotation Challenges:

• Difficult to accurately time economic cycles
• Sectors don't always follow historical patterns
• High turnover increases costs and taxes
• Requires accurate macroeconomic forecasting

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Core-Satellite Approach

The core-satellite approach is a portfolio construction method that combines a stable "core" of passive, diversified investments with smaller "satellite" positions designed to generate alpha or express specific views.

Structure:

Common Satellite Strategies:

• Active management in less efficient markets (small-cap, emerging markets)
• Sector or thematic bets (technology, clean energy)
• Factor tilts (value, momentum, quality)
• Alternative investments (REITs, commodities)
• Individual security selection

Benefits of Core-Satellite:

• Captures most market returns at low cost (core)
• Preserves potential for outperformance (satellites)
• Controls overall portfolio costs
• Allows expression of views without betting entire portfolio
• Tax-efficient core can offset satellite turnover

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Factor Investing (Smart Beta)

Factor investing, also called smart beta, is a systematic approach that targets specific drivers of returns rather than relying on market-cap weighting or individual security selection.

What Are Factors?

Factors are persistent, documented characteristics that have historically been associated with higher returns or lower risk.

Smart Beta ETF Strategies

Smart beta ETFs use alternative weighting schemes instead of traditional market-cap weighting:

Smart Beta Considerations:

CFP Exam Tip: Smart beta sits between purely passive indexing and active management. It systematically targets factors that have historically produced excess returns, at lower cost than traditional active management.

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Choosing Investment Strategies for Clients

When recommending investment strategies, consider:

Strategy Summary Table