Formula investing is a type of investment strategies where the investors follow a certain theory or formula rigidly. It can refer to the way investors handle asset allocation and making the decision of the amount of money spent on the investment.
How does Formula Investing Work?
This investment strategy decides most of the things on the investment process. Thus, it reduces the stress experienced by the investors and automates their strategies, at the same time. All the investors need to do is only to follow the set of rules from the formula and invest accordingly.
However, the drawback of this strategy is that the investors will only have little to no chance at all to adapt to the changes in the market. For instance, if there is extreme volatility, an investor can get a better result if he or she adjusts the strategy, right at that moment.
If there are investors who want to use this strategy, then the investor needs to make sure that the formula is suitable for his or her risk tolerance. Besides, the investor should also find a strategy that suits his or her liquidity and time horizon.
The example of formula investing is dividend reinvesting, ladders, and dollar-cost averaging.
The Strategies
Here are the most popular strategies for formula investing.
Dollar-Cost Averaging
Dollar-cost averaging involves buying an investment on a set schedule and at a fixed rate, regardless of its performance. for instance, an investor invests $1,000 on a mutual fund every month. Then, in a year, that investors will have $12,000 invested.
Dividend Reinvesting
This strategy involves a dividend reinvestment plan (DRIP) in order to use the payment of the dividend to purchase additional stock. With this strategy, investors can have the chance to compound his or her wealth.
Ladders
Commonly, investors use this strategy for fixed-income investment, like bonds. They buy a portfolio of bonds with various maturity dates. Then, the short term bonds will offset the volatility of long-term bonds.
Writer: Lisa Ramadhani
