You must have a robust methodology for selecting the right share, property or bond to invest in. If you select the right asset, your investment returns are likely to be very healthy in the long run.
However, if you make a mistake, it is likely to cost you money – in terms of opportunity cost and/or in real terms.
The best way to prevent making a mistake is to use a methodology for selecting the right asset that is proven to work. In this blog I outline the four different methodologies and the two that I think are best to use in combination, where possible.
There are four different asset selection methodologies
There are many different asset selection approaches which can have their own subtleties and idiosyncrasies. However, every methodology can be broadly allocated into four different categories:
1. Value investing
This involves identifying assets or sectors that are intrinsically undervalued. Markets are not always perfectly efficient and sometimes assets transact for amounts less than fair market value. This could be due to factors such as a motivated seller, misinformation, market sentiment (fear) and so on.
2. Growth investing
This involves identifying assets or sectors that have high growth prospects. This approach is less concerned with the price paid for the asset compared to its appraised value - it’s all about the idea that you can buy this asset today for $x and that price will look cheap in the future after the expected growth has materialised. This methodology requires you to form a view as to what the future growth opportunities could be which is often highly subjective.
3. Fundamental investing
This approach involves identifying the assets or sectors that have the strongest underlying fundamentals such that the asset quality is extremely high. This approach is less concerned about the price paid and usually the assets growth prospects might be already reflected in the current price. The thesis underlying this strategy is that investment returns are directly linked to asset quality i.e. you can only expect above average returns from above average quality assets.
4. Technical analysis
This
approach involves looking for trends in data and statistics (such as price movements and volume) to identify assets and sectors that
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