Do you know the answer if your financial professional asks you what type of investor you are? While it may be challenging to classify yourself off the top of your head, knowing what type of investor you are might help you avoid making knee-jerk decisions that could cost you money.
Suppose you are a passive investor primarily interested in large-cap companies, but find yourself pursuing an active investment strategy focused on small-caps. In that case, staying invested may be tough when things get rocky. Having an investment strategy that matches your investing type may make it easier to stay the course over the long haul.
Here are three of the biggest investing dichotomies that may help you identify your investment style(s).
Active Versus Passive Investing
As the name implies, active investors take an active role in choosing, buying, and selling their investments—either placing trades themselves or investing in actively-managed funds. Actively-managed funds generally have a full staff of managers and researchers working on the fund's return. Many active investors choose this strategy to "beat the market."
Passive investing, or "buy and hold" investing, does not require research, and as a result, passive investment funds tend to have lower expense ratios than actively managed funds. Passive investing is ideal for those with a long time horizon—people just starting out in the investment world or those with a few decades of work before they retire.
Growth Versus Value Investing
The next main investment dichotomy involves the overall investment goal: growth or value. Growth investments may increase in value quickly, returning high earnings to investors. Value investments are perhaps a good deal. They may be industry leaders that, for whatever reason, are currently underpriced.
Many investors tend to wind up with a mix of growth and value investments. During economic booms, growth stocks may outpace their value companions, while value stocks might be a hedge against inflation and recession.
Small-Cap Versus Large-Cap
Investors decide whether to invest primarily in large or smaller companies. Companies with a market capitalization (the number of shares multiplied by the share price) of more than $10 billion are considered large-cap companies. Those with a market capitalization of under $2 billion are small-cap companies.1 Mid-cap companies are those that fall somewhere in the middle.
Generally, large-cap companies are stable, slower-growing companies that may hold their value, while small-cap companies are smaller, riskier ones that might present an opportunity for rapid growth. To combine the two factors, small-cap companies tend to include more growth stocks, while large-cap companies include more value stocks.
By analyzing your risk tolerance, investing timeline, and willingness to invest actively, you may choose the investing style(s) that work for you. Regardless of the style, all investments may lose money.