Aggressive investment strategies attempt to maximize returns by taking a relatively higher level of risk
Recent years have seen significant pushback against active, aggressive investment strategies. Many investors, for instance, have pulled their assets out of hedge funds due to underperformance. Instead, some have chosen to entrust their wealth to passive managers who adhere to investing styles that often employ mutual and exchange-traded funds. In the first place, how do aggressive investment strategies work?
Aggressive investment strategies attempt to maximize returns by taking a relatively higher level of risk. They emphasize capital appreciation as a primary investment objective rather than income or safety of principal. Such strategies would, therefore, have an asset allocation with a substantial weighting in stocks and a much smaller asset allocation to bonds and cash.
Aggressive strategies need more active management than a conservative buy-and-hold strategy since they are likely to be much more volatile and could require frequent adjustments, depending on market conditions. More rebalancing would also be required to bring portfolio allocations back to their target levels. The volatility of the assets could lead allocations to deviate significantly from their original weights, according to Investopedia.
Aggressive strategies are especially suitable for young-adult investors because a long investment horizon enables them to ride out market fluctuations. However, regardless of investors’ age, a high tolerance for risk is an absolute prerequisite for these strategies.
Below are some investment strategies that are suitable for aggressive investors:
Small- and Micro-Cap Stock Investing
The aggressiveness of a portfolio depends on the relative weight of high-risk asset classes, such as equities, in it. Even within the equity component of an aggressive portfolio, the composition of stocks can have a significant bearing on its risk profile. For instance, if a portfolio’s equity component only consists of blue-chip stocks, it would be considered less risky than if it holds small- and mid-cap stocks.
Small-cap stock funds consist of companies selected for their potential to deliver significant returns – companies below about $1 billion in market value. They often include relatively new, unproven companies and small companies developing new products or taking other steps to enter a new or growing market. Small-cap fund managers may also look for less risky bargain buys, such as established companies with a low market value (and share price) due to a temporary market downturn.
Meanwhile, micro-cap stock funds invest in companies that are not big enough to be considered small-caps, targeting companies below about $250 million to $500 million in value. Although micro-cap stocks carry a higher risk than small-cap stocks, micro-cap investors point out that the entry price is low and the potential for payoff is almost unlimited.
A micro-cap stock can generate huge returns if a small company is acquired by a larger company. However, if it moves up to small-cap size and outgrows the micro-cap fund on its own, the returns will be limited to the growth from micro-cap to small-cap, as the fund manager will need to sell shares in any companies that no longer meet the fund’s micro-cap definition, according to HowStuffWorks.
Belonging to a group of securities known as derivatives, options are contracts that offer investors the right to buy or sell the underlying asset at an agreed-upon price during a certain period or on a specific date. They are commonly used to hedge against a declining stock market to limit downside losses, generate recurring income or for speculative purposes such as wagering on the direction of a stock.
The leverage component, however, contributes to options’ reputation for being risky. It is therefore important for investors to understand that when they buy an option, they must be correct in the direction, magnitude and timing of the stock’s movement. In other words, to succeed, they must correctly predict whether a stock will go up or down, how much the price change will be, and when it will happen.
Aside from this, options involve other risks that investors must be aware of before trading. Many of the risks associated with options can be modelled and understood. Investopedia, for instance, has assigned Greek letter names to individual risks:
- Delta – represents the directional risk: the change in option price per unit (point) change in the underlying price; interpreted as the hedge ratio or the equivalent position in the underlying security
- Gamma – measures the change in delta per unit (point) change in the underlying security; tells how much more the directional risk increases as the underlying security moves
- Theta – known as time-decay risk: change in option price per unit (day) change in time; represents how much value an option loses as time passes
- Vega – measures the sensitivity of an option to volatility; represented as the change in option price per unit (%) change in volatility
- Rho – represents the option’s sensitivity to interest-rate risk: the change in option price per unit change in interest rates
Although the investment strategies discussed above carry higher-than-average risks, when they are properly implemented, they will generate higher-than-average returns. With the right strategies, aggressive investors can get high level of returns.