Several behavioral patterns emerge among investors again and again, in my experience as an advisor. One happens with people who understand the need to diversify to reduce risk and, over time, increase the chances of a better return. However, despite that “head knowledge,” plenty of those investors still like the idea of overweighting one particular asset class. Or maybe they have an itch to own a particular stock or fund.
It’s OK to have a few investments outside of your regular allocation, as long as you understand the character of various asset classes. While fast-moving techs have been exciting to watch and own this year, for example, you only need to think back a few months, to 2022, for a reminder of how volatile growth stocks can be.
Related: Sign up for stock news with our Invested newsletter.
It may seem obvious, but sticking to a long-term investing strategy and not veering off course is essential to ensuring that investing your money, well, actually makes money. Here’s a look at some of the largest asset classes, and how investors might apply a winning strategy to each:
— Dividend stocks.
— Growth stocks.
— Bonds.
— Value stocks.
— Blurred lines.
Dividend Stocks
Dividend-paying stocks can provide investors with a steady stream of income, which can help them reach their financial goals and can help offset losses during periods of market decline.
Taylor Kovar, founder and CEO of Kovar Wealth Management in Lufkin, Texas, says dividend stocks “are like that steady, dependable friend who always shows up with pizza when you’re in need.”
He adds that dividend payers are great for the long term, regularly doling out a portion of their profits to shareholders.
Not only are dividends a good way to generate income to pay for regular expenses, but they can also be reinvested to purchase more shares.
“Value stocks are like those underrated movies that critics love but aren’t box office hits. They’re shares in companies that may be underappreciated by the market, but like a sleeper hit, they have great potential.” – Taylor Kovar, founder and CEO of Kovar Wealth Management
Christopher Manske, president of Manske Wealth Management in Houston, says investors should select a reasonable yield that they must earn. From there, they can identify the total amount of money they need to invest at that yield to generate income to cover expenses.
As a rough example for an average-length retirement, he says, “If you select a 4% yield and you need to cover $5,000 a month in expenses, you’re going to aim to save up and buy $1.5 million in dividend-paying stocks that pay at least 4%.”
Growth Stocks
Investors get most excited about the potential of growth stocks, but it’s important to understand the inherent risks.
Companies that tend to reinvest revenue into high-potential projects, rather than paying dividends, are categorized under growth. These stocks have the potential for substantial capital appreciation over time, making them a good choice for long-term wealth accumulation.
Today’s batch of growth stocks includes some of the most well-known and heavily owned stocks in the market, such as Apple Inc. (ticker: AAPL), Microsoft Corp. (MSFT), Nvidia Corp. (NVDA), Alphabet Inc. (GOOG, GOOGL), Amazon.com Inc. (AMZN), Meta Platforms Inc. (META) and Tesla Inc. (TSLA).
As we saw in 2022, growth stocks can get hit especially hard during times of inflation. That’s because inflation reduces the long-term forecasts for a company’s free cash flow growth, which is a typical growth metric.
For that reason, investors should not get too giddy about the name of this asset class.
“Growth stocks, just from that term, can often make beginner investors think that by buying in, they’re going to be on a rocket ship to the moon,” says Richard Gardner, founder and CEO of Modulus Global in Scottsdale, Arizona. His company develops technologies, including artificial intelligence, for financial clients.
However, Gardner adds, investors have to understand that growth stocks are prone to volatility.
“You really want to choose a diverse set of growth stocks so that if one or two take a nosedive, the others can balance out your losses,” he says.
Kovar calls growth stocks the “high-energy, roller-skating daredevils. They can dazzle you with high returns, but they’re not without their wipeouts.”
He notes that these stocks are for investors who can stomach some risk “and have the patience to let them do their thing. But remember, not every ride ends up at the top of the roller coaster, so watch these guys carefully,” he says.
Related: How to Invest With Little Money
Bonds
Fixed-income securities are not a one-size-fits-all asset class, despite their reputation as sleepy backwater investments compared with equities.
I’ve known investors, even some well into retirement, who avoid bonds because they have more fun watching their stocks increase in value, while bonds can languish.
Sure, bonds return less. That’s a given. But you don’t own bonds for their eye-popping returns. That’s the job of growth stocks. Bonds add ballast to a portfolio, and can help mitigate stocks’ volatility. While that seems boring during a roaring bull market, you’ll appreciate bonds’ income during a stock-market correction.
“Bonds are your classic ‘slow and steady wins the race’ tortoise,” says Kovar. “Holding bonds is like having an airbag in your portfolio: They can cushion the impact when the stock market takes a tumble. Just remember that when interest rates go up, bond prices usually head south.”
In 2022, that’s exactly what happened, causing stocks and bonds to fall simultaneously. That doesn’t occur often, but under a certain set of circumstances, you’ll see that unfortunate synchronization.
That’s not a reason to avoid bonds, though. And forget the idea that bonds are the proverbial “widows and orphans” safe-haven investment. They carry their own risks, as we saw in 2022, but they serve a purpose for investors who need income, or who want to offset the volatility of stocks.
In addition, fixed-income instruments come in different flavors. For example, longer-term bonds have higher returns, but greater risk. That’s because nobody has visibility into where interest rates might be 20 years from now, and what those bonds might actually be worth down the road. It’s much easier to have some insight into interest rates within the next couple of years.
Likewise, high-yield bonds, which are debt issued by companies deemed less likely to pay their debt, have a higher return, but also higher risk.
Value Stocks
A value stock is a type of equity that’s considered undervalued by the market. It often trades at a price lower than its intrinsic value, based on fundamentals such as cash flow, earnings and growth prospects.
These stocks are typically companies that are financially stable, have solid fundamentals and may be temporarily overlooked or out of favor for various reasons.
Value stocks are sought after by investors looking for bargains and potential long-term gains. These investors are willing to wait for market sentiment and valuations to catch up with the company’s true worth.
An example of a value stock is Bank of America Corp. (BAC), which has sound fundamentals but was caught in the downdraft of the regional banking crisis earlier this year.
“Value stocks are like those underrated movies that critics love but aren’t box office hits,” says Kovar.
“They’re shares in companies that may be underappreciated by the market, but like a sleeper hit, they have great potential,” he says. “They’re for those who enjoy digging through the bargain bin and have the patience to wait for the market to recognize the company’s true worth.”
But, he cautions, sometimes there’s a reason a product is on the discount rack. Investors should do research to understand whether a fundamentally good company is temporarily undervalued, whether a beaten-down stock is showing slower growth or if it has some other problem that’s scaring off institutional investors.
Blurred Lines
Jim Polk, head of equity investments at Homestead Funds in Arlington, Virginia, says the market’s perception of value has changed over time.
Traditionally, the energy and financial sectors were considered value, but energy was the hot growth item in 2022. Polk points out that the line between growth and value has blurred.
“Companies with good long-term prospects trading at reasonable valuations are increasingly being considered value,” he says. “Warren Buffett has often said that it’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price. In other words, cheap does not necessarily mean value.”
More from U.S. News
Bonds vs. Stocks: Differences in Risk and Reward
Is the Stock Market Open Today?
7 Undervalued Stocks to Buy Now
How to Invest Money to Make Money originally appeared on usnews.com
