Passive vs. Active Investing

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Passive Investing

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Welcome back to Pave Academy’s Module 3 -Understanding Different Investment Strategies.

After establishing a solid foundation on some common financial topics, such as risk, return, and the importance of aligning investments with your personal goals, we're now ready to explore the landscape of investment strategies to help you define your investment approach. Today’s goal? Deciphering Passive and Active Investing.

Passive and Active Investing are two strategies employed by investors worldwide. But what do these terms mean, and how do they differ?

Let's start with Passive Investing. This strategy is commonly associated with long-term investing. It involves buying and holding a portfolio of investments that mimic a market index, such as the S&P 500.The main idea is not to outsmart the market but to flow with it. It is difficult to try and time the market and overweight specific sectors and industries to come out ahead. Historically, investing in indices and Passive Investing has outperformed investing with active managers.

The advantages? Lower fees and less time spentmonitoring markets and making decisions. This is because the passive strategytypically involves fewer transactions.

But there's a caveat:

Passive investors relinquish control over specific investment choices. You're trusting the entire market to do well. Yet, despite the hands-off approach, Passive Investing can generate significant returns over the long term, particularly when compounded.

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Active Investing

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Now, onto Active Investing: In this approach, an investor chooses specific investments to outperform the overall market and can decide to move in or out of cash. Some people define Active Investing as market timing: you take a portion or all of your investing capital out of risky assets and put it into cash, waiting for a better opportunity to become fully invested. Better opportunities can come at lower prices or when the economic environment becomes more stable.

An active investment strategy traditionally centers around buying and selling individual stocks to take advantage of long-term fundamental opportunities. In contrast, market timers purchase stocks, sell them, and constantly monitor the market, aiming to exploit price fluctuations. Active Investing allows you to cherry-pick investments with the hope of beating a buy-and-hold strategy. In doing so, the hopes for higher returns generate higher fees and the potential for increased risk. After all, frequent trading, while providing opportunities, also means more chances for missteps. Active Investing can offer higher returns when executed well, particularly in the short term. However, it requires a serious time commitment, a well-thought-outtrading plan, and superior analytical tools.

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Which Strategy Suits You?

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So, which strategy suits you? It's not a one-size-fits-all answer. It depends on your financial goals, risk tolerance, time commitment, and your interest in market analysis.

Just know that only 15% of professional investors beat the market in any given year, so you need solid financial analysis tools to do better than passive investing even for one year; forget about doing it consistently over a long time.

The other element that plagues active investors is to know when a particular investment is becoming unfavorable. This element recalls the importance of risk management, and any active investor needs to have a mechanism in place to identify investments that are no longer attractive due to changing market conditions. If you do not have a process to tell you when you need to liquidate one or more of your positions, you lack a disciplined approach to trading, in which case you are relying on hope…and luck. Not a stable foundation for success.

Growth vs. Value Investing

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Growth Investing

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Hi every one! Let’s continue our conversation about different investment strategies. Today, we unpack two investment styles: Growth and Value Investing.

Now, what does Growth versus Value Investing mean in practical terms?

Growth Investing means focusing on a company or group of companies expected to exhibit strong growth in earnings and revenues. Growth stocks tend to have a competitive new product or service that is well-positioned to profit from increased demand and potentially move into new markets with excellent prospects for expansion. The revenue growth, not necessarily earnings, is forecast to be higher than the average company, so its stock price is expected to increase.

Growth companies often belong to technology, biotech, or green energy sectors. Earnings are cycled back into their business rather than paying out dividends because the firm expects a high return on investing in their company's growth. The allure of Growth Investing lies in the possibility of high returns. But with high reward comes increased risk. Growth stocks can be more volatile and may also be overpriced due to investor enthusiasm. Yet, if you're an investor with a high-risk tolerance, a long investment horizon, and a love for innovation, Growth Investing could be an exciting journey.

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Value Investing

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Where as growth investors focus on forecasting future revenue growth, value investors screen for companies whose stock price represents a good bargain today. Value stocks are often found in traditional industries like utilities, manufacturing, and financial services. They're typically established companies with stable revenues, often paying dividends. Value Investing offers less risky opportunities and the satisfaction of finding bargains, but remember these' bargains' may take time to provide substantial returns. Some are trading at a low value because their business model or prospects are not promising. A stock may look like a bargain, but it is cheap because it’s not a worth while investment.

Value opportunities are created either from a micro or macro perspective. For example, suppose a company reports surprisingly bad earnings or makes a poor management decision or product introduction that causes an overreaction in its stock price. In that case, that may create enough value relative to its long-term fundamentals to attract value buyers. If an adverse economic event occurs, such as surprisingly poor employment numbers or a spike in inflation, it can cause entire sectors to be adversely affected..

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Which One Suits You?

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Which universe should you travel in? Whether you're chasing future stars with Growth Investing or seeking underrated performers with Value Investing, your choice ultimately ties back to your personal financial goals, risk tolerance, and investment horizon. Value stocks carry less risk because they tend to be more established firms with a healthy dividend payout, so the income stream coming from dividends cushions any stock price declines that may occur. Growth stocks tend to have more price volatility, but investors are compensated for that by the potential for significant price appreciation.

Long-term vs. Short-term Investing

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Long-term Investing

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As we continue to demystify investment strategies, today's head-to-head match sees Long-term Investing squaring off against Short-term Investing.

In the investing world, one key distinction is based on time - how long you intend to hold on to your investments. This distinction can significantly influence your investment approach.

Let's start by exploring Long-term Investing. Theoretically, you're buying and holding assets for years and possibly decades, allowing them to grow over time. A company like Microsoft could be an example of a long-term investment. These stocks have demonstrated consistent growth and stability over the long run.

What is the appeal of Long-term Investing? It allows for potential compounding of returns and may be less stressful, as you're not as concerned with short-term market fluctuations. But it requires patience and a disciplined approach, as returns may take time. For long-term financial goals, such as retirement, long-term Investing might be the route for you.

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Short-term Investing

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On the other end of the spectrum, we have Short-term Investing. Short-term investors aim to profit from rapid changes in the price of assets. Short-term can mean different things to different market participants. Some short-term traders will hold stocks for only a few minutes in day trading, while others will enter and hold for a few weeks or months before exiting. Day traders focus on extreme volatility assets such as cryptocurrency or will trade in short-term options on highly volatile stocks. These assets often see significant price fluctuations, allowing the possibility of quick gains.

The advantages of Short-term Investing include the potential for fast profits and the excitement of actively engaging with the market. However, this strategy can be riskier and more stressful, requiring constant monitoring of the market and maintaining rigid discipline. Otherwise, losses can rack up in a very short period of time.  A tiny percentage of day traders beat the market, while many lose a significant amount of their capital. In that world, we often hear about the gains that are made but rarely about the losses that are registered.

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How Can You Balance Both?

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Whether you opt for the steadiness of Long-term Investing or the thrill of Short-term Investing - or perhaps a combination of both - always remember, there's no one-size-fits-all strategy in investing. Your path depends heavily on your personal goals, risk appetite, and the time you can dedicate.

If you have the proper tools, taking a Long-term investing approach but trading on a monthly or multi-month horizon by identifying stocks that are not doing well and replacing them can be a rewarding way to invest. Adjusting the portfolio to be more sensitive to higher inflation or lower interest rates the overall market is beginning to favor can be a logical approach. The difficulty is anticipating those changes and selecting those stocks that will perform well under those circumstances.

This is the strategy that we have focused on at Pave. Our analytics are geared toward monitoring for changes in the investing climate to adjust your personalized portfolio's risk and construction.  

The key is striking a balance that resonates with your financial journey.

Impact Investing

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What Is Impact Investing?

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Investment strategies such as the ones outlined above represent different investment approaches, and you want to adopt the ones that resonate with you. In some ways, they reflect your investment beliefs but not necessarily your values. However, you can look at investing in such a way that you hope your investment dollars make a statement by supporting companies trying to make the world a better place.

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Finding your investing voice isn't just about making money; it's about structuring your investments around causes you believe in and letting your money do the talking.

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That is the promise of impact investing. Investment is not just about saving for our retirement or building wealth. It's about shaping the world of tomorrow, today. It's about knowing that our money can help a child get an education, support an innovative startup solving our most demanding challenges, or ensure that the planet we call home thrives for generations. Our investments, when approached with mindfulness and intent, have the potential to be not just a tool for personal wealth accumulation but also a powerful instrument of global change.

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How to Balance Ethics & Finance

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So, how can you ensure your portfolio reflects your financial ambitions and ethical convictions? Let's delve deeper:

1. Support businesses that mirror your values. If climate change keeps you up at night, consider backing renewable energy firms.
2. Likewise, consider divesting from industries that contradict your principles. Every dollar you pull back is a clear vote against unsustainable practices.
3. Be proactive in your research. Seek out companies with stellar ESG (Environmental, Social, Governance) ratings. These companies operate sustainably, treat their employees well, and have solid governance structures.

The growth trajectory of impact investing has been nothing short of a moonshot. The Global Impact Investing Network reported that the market size grew to a whopping $715 billion in 2020. And with millennials and Generation Z showing an overwhelming inclination toward value-aligned investing (95% and 90%, respectively, according to a 2023 Morgan Stanley survey), investment culture is definitively turning.

Navigating this new path may seem daunting. But that's where Pave comes in. We’re an investment platform designed to simplify and personalize impact investing. With Pave, you can align your investments with your values while maintaining financial performance.

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Aligning Your Investments with Your Values

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If you're interested in green technology, renewable energy, and sustainable farming, why shouldn’t your portfolio reflect that? Why invest in companies that don't match your drive for a better world?

We've got five strategies to help you hone your investing voice and ensure your portfolio is not just a collection of numbers but a reflection of who you are and what you believe in:

• Reflect inward: The first step to finding your investing voice is to define what matters to you. Is it clean energy? Is it gender equality? Access to education? The fight against poverty? Pinpointing your passions will guide your investment decisions and help align your portfolio with your values.
• Get informed: Once you know the issues you want to support, it's time to dive deep into research. Understand the companies you are considering investing in. Look beyond the financials. Understand their mission, their vision, and their actions. Are they contributing positively to the cause you care about?
•  Embrace divestment: If you discover companies or entire industries that contradict your values, don't be afraid to pull your investments. Divestment is a powerful tool to voice your disagreement with practices that don't align with your ethical framework.
• Seek out companies with high ESG(Environmental, Social, Governance) ratings: These firms are leaders in sustainability, ethical practices, and good governance. They're worth considering for inclusion in your impact-focused portfolio.
• Utilize platforms that help personalize your portfolio: Time is of the essence in this fast-paced world. You need tools that can do the heavy lifting for you. Look for platforms that can curate a portfolio according to your values, enabling you to invest in companies that align with your ethics and do good for the world while pursuing financial returns.
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The Ethical Tradeoff

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What is the value of your values?

It may sound funny, but it is a serious question. There are some realistic concerns surrounding how the major ESG rankings are calculated. However, much of the resistance to ESG investing has come from those who feel they were missing out, as several defense and energy stocks performed better than the general market.

In an ideal world, your values, as reflected in a stock portfolio of socially responsible companies, will rise to the top. Therefore, you would not be in conflict with investing the “right way” versus trying to maximize your investment dollars. However, there will be times when you may feel the general market is doing much better than your choices. Sometimes, the sectors and industries you have excluded will outperform. Therefore, balance the need for your capital to go toward worthy companies versus the need for it to grow at the fastest rate possible. It is good practice to consider the non-economic value of investing in companies you want to support before you make a virtuous choice.

Just as you will enjoy it if your portfolio is doing better than the broad market indices, understanding that there will be times when the opposite situation will occur can help you not create a portfolio built upon emotional reactions. Keeping emotions in check is critical because acting out of frustration or fear tends to beat the worst possible moment to meet your investment objectives.

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We at Pave seek to select stocks for your personalized portfolio that will track the benchmark that matches your risk tolerance so you can have a personalized portfolio aligned with your values and investment goals.