In a Volatile Market, What Investment Strategy is Best for You?

What investment strategy is best for you? Growth, value or GARP?

A volatile market may be just what the doctor ordered—at least for those investors who feel holding an investment for 30 days is as likely as holding an investment for eternity. Although most of the day trading operations that popped up in cities and towns across the country in the 90s no longer exist, I can assure you that the idea of trading for a quick profit exists now more than ever. The amateurs that frequented such places placed usually their trades using an excessive amount of margin, and had success riding an incredible bull market. Those investors are now likely extinct. What remains is a the more sophisticated investor sitting at home with access to more research than ever, trading on his laptop or now even his smart phone, still looking to make a quick profit.

Professional traders have been around for many years. They are now responsible for the highest percentage of daily trading volume and are getting more attention than ever. What has changed with these professional traders is that they have become more active, manage a lot more money, are willing to trade on smaller percentage changes, and hold positions for a shorter amount of time.

It may be hard to believe, but the average holding period for stocks on the New York Stock Exchange (NYSE) is down to under a minute. Some estimates have the average holding period down to between 11 to 22 seconds. It has gotten to the point that some of the largest trading operations located on the West Coast are picking up real estate on the East Coast just to shave fractions of a second off their execution times.

For those of us who manage portfolios for ourselves as well as our clients, and who still value the benefits of fundamental analysis and implementing an investment strategy that is understandable, reasonable and, hopefully, repeatable, the thought of holding a position for a few seconds doesn’t cross our minds. We are much more interested in running a tax-efficient portfolio that is designed to pursue the clients’ stated goals and objectives.

Growth Investing

When considering a more fundamental or disciplined approach to investing, many turn to what is commonly known as growth investing or value investing. Growth investors are those that invest in companies that have consistently beat their earnings estimates in previous quarters. The expectation is that those companies will continue to outperform in the future. This strategy, pioneered by Thomas Rowe, Jr., of T. Rowe Price, typically works well as long as the company continues to meet or exceed expectations. If they don’t, share prices tend to fall rapidly and, in many cases, by a large percentage. Why does it drop by such a large percentage? Possibly because all of the growth investors want out at the same time and the value investors are looking more at the fundamentals, and still feel the shares are overpriced.

Value Investing

Value investors, on the other hand, are more interested in the fundamentals of companies. They are more likely to identify companies that have a low price-to-book ratio, little if any debt, a low price-to-earnings ratio, and possibly high dividend yields. Purchasing companies that are currently under public scrutiny and are out of favor but have good fundamentals is typical for a value investor. Value investing dates back to 1928, when Ben Graham and David Dodd began teaching the strategy at the Columbia Business School. One of the best-known investors that pays attention to attributes of value investing is Warren Buffett, Chairman of Berkshire Hathaway. Primary risks for value investors are that the companies they invest in don’t improve and the fundamentals continue to get worse. For example, a company with a price-to-earnings ratio of 5-to-1 can quickly go from infinity to one if the company begins to lose money. That too can cause a serious percentage decrease in the value of the shares.

Growth at a Reasonable Price

If you feel that both of these strategies have merit but are unsure of which would be best for you, than why not consider “Growth at a Reasonable Price,” commonly referred to as GARP, a strategy popular with legendary investors like Fidelity’s Peter Lynch. GARP investors look for companies that have attributes of both growth and value investing. They look for companies that are somewhat undervalued but also have solid sustainable growth potential. Simply put, earnings growth matters, but so does valuation. The idea is to purchase companies that have characteristics of both growth and value. It is not to develop a portfolio of some companies that only have value characteristics and some companies that only have growth characteristics. Some might say this is the best of both worlds. It allows the portfolio opportunity to perform well as earnings continue to improve and also attempts to help protect on the downside in the event the company’s earnings are a disappointment.

Don’t be overly confident in any strategy you choose. There is no magic strategy that works every time and in every economic environment. Having a well thought out Private Wealth Design that keeps you from making emotional decisions when your strategy happens to be out of favor trumps any investment strategy. If you are still interested and believe you can make your fortune by making millions of trades in a single day, you are welcome to give it a try – but your competition has a lot of computing power and experience that you don’t. I think you are better off going to a casino. Casinos have people and processes in place to not let their customers get too far over their heads, and you get free drinks.

Read the article on U.S. News & World Report here! >

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for individuals. To determine which investment is appropriate, please consult your financial advisor prior to investing. All performance references are historical and are not a guarantee of future results.