We begin with fundamental analysis because it is one of the oldest and most basic forms of investing styles. Primarily used for researching and analyzing equities (individual stocks, rather than mutual fund selection), fundamental analysis is a form of an active investing strategy that involves analyzing financial statements for the purpose of selecting quality stocks.
- Core and Satellite: Core and Satellite is a common and time-tested investment portfolio design that consists of a “core,” such as a large-cap stock index mutual fund, which represents the largest portion of the portfolio, and other types of funds—the “satellite” funds—each consisting of smaller portions of the portfolio to create the whole. The primary objective of this portfolio design is to reduce risk through diversification (putting your eggs in different baskets) while outperforming (obtaining higher returns than) a standard benchmark for performance, such as the S&P 500 Index. In summary, a Core and Satellite portfolio will hopefully achieve above-average returns with below-average risk for the investor.10
- The Dave Ramsey Portfolio: Popular talk show host and generally respected personal finance guru Dave Ramsey has long-supported his four mutual fund portfolio strategy for his listeners and fans. Dave’s wisdom is in his simplicity; his delivery and financial methods are easy to understand. However, the wisdom stops there. These four mutual fund types will often find fund overlap, which means there is little diversity. Furthermore, lower-risk assets, such as bonds and cash, are completely absent from the portfolio.1112
- Modern Portfolio Theory: Modern Portfolio Theory (MPT) is an investing method where the investor attempts to take a minimal level of market risk to capture maximum-level returns for a given portfolio of investments. An investor that follows the tenets of MPT may use a core and satellite approach, as described in number 1 above. At the core of investment philosophy, every investor would like to achieve the highest possible return without taking extreme levels of risk. But how can this be done? The short answer is diversification. According to MPT, an investor can hold a particular asset type, mutual fund, or security that is high in risk individually but, when combined with several other asset types or investments, the whole portfolio can be balanced in such a way that its risk is lower than some of the underlying assets or investments.13
- Post-Modern Portfolio Theory (PMPT): The difference between PMPT and MPT is the way they define risk and build portfolios based upon this risk. MPT sees risk as symmetrical; the portfolio construction is comprised of several diverse investments with various risk levels that combine to achieve a reasonable return. It is more a big picture view of risk and returns. A PMPT investor sees risk as asymmetrical; the way investors feel about losses is not the exact opposite mirror image of how they feel about gains, and each economic and market environment is unique and evolving. PMPT sees that investors do not always act rationally. Therefore PMPT accounts for the behavioral aspects of the investor herd, not just the mathematical model that MPT follows.14
- Tactical Asset Allocation: Tactical asset allocation is a combination of many of the previous styles mentioned here. It is an investment style where the three primary asset classes (stocks, bonds, and cash) are actively balanced and adjusted by the investor with the intention of maximizing portfolio returns and minimizing risk compared to a benchmark, such as an index. This investing style differs from those of technical analysis and fundamental analysis in that it focuses primarily on asset allocation and secondarily on investment selection. This big-picture view is for a good reason, at least from the perspective of the investor choosing tactical asset allocation.