The 4 Types of Stock Market Investing
- The Millennial Millionaire
- Dec 12, 2020
- 4 min read
Initially, many see investing as something quite daunting. However, if you can get to grips with how to invest early on, you’ll likely achieve financial independence far quicker.
The whole idea of investing is to make your money work for you. We’ve previously been through 8 passive income streams here. As mentioned in that blog, there are two forms of passive income:
1. Put the time in upfront and allow that work to pay you passively in the future (like Youtubers, for example)
2. Put in the money and make that money work for you
We’re focusing on the latter in this blog – and the different ways in which you can gain a return on your investment.
The types of investing we’ll look into are:
· Value
· Growth
· Dividend
· Index fund
Value Investing
The idea of value investing is to buy stocks that seem to be undervalued – buying them in the hope that their price is corrected to a fairer value in the near future.
Of course, it’s a bit more complex than that – if we knew which stocks were undervalued, we would buy them straight away on our road to riches. But, there are a few key indicators you can look at to help you decide on whether stocks are undervalued.
Probably the most talked about ratio regarding stocks is the P/E Ratio (Price to Earnings Ratio). This takes the price of a share, and divides it through by the profit for each share. Stocks in the FTSE 100 (The UK’s biggest listed 100 companies) tend to trade around the 10-15 P/E Ratio.
When you see companies with a P/E Ratio less than 10, they will often be quite good value – but you may want to look into whether that year had some extra income that is not representative of future income. Also, the company’s position in the market may be changing – as competitors may be gaining an edge.
P/E Ratios are good for determining the value of stable companies – however, in high growth industries such as tech, the ratio can be negative due to initial losses. Also, if income is expected to grow massively in future years, a company may trade at a 30 + P/E ratio, allowing the future growth to be priced into the stock price.
Growth Investing
Growth investing is where you invest in a company, not due to its current income, but for its future outlook. This is normally because you expect it to grow massively in the future.
The sorts of stocks we’d put in this category are Apple, Amazon, Facebook etc. They experience high growth, so the traditional means of valuation may not be suitable.
A couple of metrics can help us decide on whether growth stocks are worth investing in:
· PEG Ratio
This is the P/E Ratio divided by the growth in earnings we’re expecting. A value above 1 indicates that the stock is overvalued, where below 1 indicates good value.
· Forward P/E Ratio
This is very similar to the P/E Ratio – but instead of taking the earnings per share from the previous year, instead it takes the projected earnings for the future year.
Both of these can be good indicators of when to buy growth stocks. However, you should look into companies in more detail before putting your money into them. For example – none of these ratios would have highlighted Tesla as a great company to invest in a year ago!
Dividend Investing
Einstein once declared compounding as the 8th wonder of the world – and dividend investing is all about putting this to practice.
The idea with dividend investing is to get back a decent amount of the sum invested, regularly each year. Some companies offer between 5-10% in dividends each year! And others, with lower dividend payments, increase their dividends each year.
Looking to the future, if you build up sufficient dividend stock positions – you could potentially live off of the dividends in the future, funding your retirement! As the stocks should increase in line with inflation – this will provide a good increasing income for when the time comes to put up your feet.
The key things to look out for are:
· How often the company pays out its dividend
· If the dividend is increasing and how long for
· The industry the stock operates in + whether it is at risk of a disruptor
As with any investment – you should try to diversify amongst many stocks in many industries – because if a company goes bust, there goes your income.
Index Fund Investing
Finally, it wouldn’t be a Millennial Millionaire blog without touching on index funds. The issue with the other types of investment are that they involve a degree of choice – either from yourself or portfolio managers.
It’s been proven many times that the market will outperform anyone picking stocks in the long-term, and when you start considering management fees – index funds are the best way to compound your wealth. With the other types of investment, you’ll likely purchase ETFs (Exchange Traded Funds) to allow you to hold a diversified position.
If these ETFs return 10% a year, while the market returns 9% a year – they still may not be the better investment. Why? Fees. ETFs can often have fees of over 1% - as soon as you start factoring these in, the better option is often the index fund.
Summary
The best strategy when it comes to investing is to not put all your eggs into one basket. Therefore, adopting a mix of Value, Growth and Dividend Investing strategies is likely to give you the best outcome.
Obtaining the right balance between these strategies can be quite difficult and your investment methods will be personal to you and your circumstances. So, it is important to do your own research and think about what it is you want from your investments before you invest. If you’re struggling for a place to start; I would suggest starting with index fund investing, which achieves a balance of all three of these strategies.
The best way to carry out any of these investment strategies is to do so within a Stocks and Shares ISA. I've broken down the best offerings here - so feel free to take a look!
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