Long-term investors likely know the importance of diversification in a registered retirement savings plan (RRSP) as a way to minimize risk while maximizing returns.
It requires a healthy balance of sectors, geographic regions and asset classes. It should also include a mix of investment styles.
There are many, under a variety of terms, that can be boiled down to four basic styles:
Value: buy low, sell high
Value investors look for equities trading below their true, or intrinsic, value. They want to buy at a bargain price before the market realizes a stock or sector’s earnings, or profit, potential.
In what is called a bottom-up approach, bargain hunters such as Warren Buffett scour corporate earnings statements and apply metrics to determine if a stock is trading below, or above, its true value. If the price is lower, they buy. If the price is higher they sell.
Waiting for the market to recognize the value of an equity could take time, which makes value investing great for RRSPs because investments can grow sheltered from tax until they are withdrawn in retirement.
The least expensive way to invest in value stocks is directly through large cap companies with stable earnings growth, but interpreting earnings statements can be difficult.
For a fee, professional money managers will select potential bargains either directly or in specific value-style mutual funds.
Investors who believe the entire market is undervalued can pay much lower fees through market-weighted exchange traded funds (ETFs) that track indices such as the TSX Composite, the S&P 500, or sector-specific ETFs.
Growth: ride the wave
The growth style of investing targets the stocks of companies with growth expectations beyond most other stocks.
Growth stocks tend to trade at higher price levels than value stocks in relation to earnings, with the expectation of stronger returns regardless.
Technology stocks have been prime examples of growth stocks but these have crept into value territory as earnings growth becomes more consistent.
Growth investors often take a top-down approach, starting with the potential for growth in entire sectors, and individual stock selection is a secondary consideration. Smaller companies with more erratic earnings in growth sectors tend to make good growth stocks.
Market-weighted ETFs are also available for growth sectors, along with mutual funds that employ growth strategies.
Passive: set it and forget it
A passive style is ideal for RRSP investors who don’t want to spend a lot of time worrying about the markets.
Passive investors tend to create diversified portfolios that track indices and sub-indices through low-cost, market-weighted ETFs.
Passive investing works well in RRSPs because, despite short-term fluctuations, major indices have always risen in value over long periods of time despite short-term fluctuations.
Like value and growth, there are passive ETFs and mutual funds available on the Canadian market.
Compounding growth: time is on your side
A compounding growth style is especially effective for investors nearing or in retirement who need a reliable source of income beyond the whims of equity markets.
A compounding growth style often becomes more prominent in a broader portfolio as the investor gets older.
With the massive spike in interest rates over the past two years, guaranteed growth is now achievable through guaranteed investment certificates (GICs), which are now yielding above five per cent annually.
Maturities for GICs and other fixed income such as bonds can be staggered over time to provide cash as often as possible to either spend, or be reinvested in more fixed income at the best going yields.
Shares in companies with long histories of paying and growing dividends can also compound savings, provided they are reinvested in more of the company’s stock through dividend reinvestment programs (DRIPs).
It’s important to know that dividend stocks are riskier than GICs because they are subject to market volatility, and dividends are paid at the discretion of the company.
Specific dividend compounding mutual funds, ETFs and real estate investment trusts (REITs) are also available on the Canadian market.