Investing in Mutual Funds: More Investing Strategies
You've read about our first two basic strategies in Investing in Mutual Funds: Strategies. Read on for the next level strategies.
3. Doing The Opposite
This is perhaps the hardest to follow. This entails doing the opposite of what everybody else is doing. You become a 'contrarian' or 'value investor'.
Value investing pre-supposes that stock markets always act in cycles. So when you accumulate stocks during a down cycle, you get to buy these stocks at very cheap prices. In a few years, the cycle will rebound and you can reap very good returns.
The reverse logic applies. When the market is euphoric, many 'growth' investors may chase stock prices to ridiculous levels. The 'contrarian' investor will sell out his holding and wait for the down cycle to come before he buys again.
Take the Asian crisis of 1997/98 for example. Many people said that this was the most severe economic crisis Asia has ever had to face and that it would last for more than 5 years. An investor employing the 2nd strategy of 'growth' would sell out his entire equity holding and keep some in cash, and maybe a bit in bond mutual funds. A 'contrarian' investor would accumulate equity mutual funds.
Of course this strategy suffers from the same drawbacks as the previous one. Chief of which is that it is extremely difficult to catch market timing. Nobody can say for sure that the market has bottomed out, or reached its peak. Everyday there are a lot of opinions and confusing signals. You need to have nerves of steel to be able to say 'sell' when everyone is screaming 'buy'.
But if you think you might be particularly good at being a contrarian, you would want to plan your investments carefully over time. Do not commit all your funds into a mutual fund all at once. Keep some money to buy some more if the prices drop further, this way you will get a better average.
4. Investing During A Recession.
In a recession, mutual funds have a great advantage over stocks. If you have been a stock investor all these years, you would realize that you can't do much in a recession, except to stay in cash as much as possible.
But with mutual funds, there is a way to make money even in a recession, and that is through debt funds. This is how it works. Recall that interest rates falls lead to higher bond prices. In a recessionary environment, interest rates generally tend to fall. This is because borrowing activity decreases dramatically, and banks have to lower their interest rates in order to attract loans. Consequently the rates which they pay out have to be lower as well. In such a scenario, bonds which pay a fixed higher coupon become extremely attractive.
Managers of bond mutual funds will sell a part of their bonds when there is a huge capital gain to be made, thereby returning handsome rewards to the holders of such mutual funds. In recessionary times, bonds have been known to give 20% - 30% returns in a year.
If you are a long term investor employing strategy 1, you would have a small exposure to bonds in your portfolio. If you are a growth investor employing strategy 2, you would shift all your money out of equity funds and into bond funds when a recession starts to hit. If you are contrarian investor, employing strategy 3, you may increase your bond exposure when everyone in the market seems to be euphoric, and you think a recession might be coming.
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