Are you someone who lives and dies on your schedule? Or do you prefer to make spontaneous decisions? Your answer could dictate the type of investment schedule you choose: systematic or discretionary investing. Both are viable investment strategies, but they vary widely in terms of how they work and how they approach investors.
If you are a scheduler and books specialist, systematic investing will be a familiar concept to you. If you tend to take things as you go and adapt on the spot, discretionary investing can be a more natural approach. There’s no wrong answer, but getting it right means sticking to whatever strategy you choose.
Systematic investment strategy
Specifically, systematic investing is a planned investment approach. Systematic investment plans (SIP) involve paying a specific amount of money at specific intervals over an extended period. For example, you can choose to contribute $ 500 on the first of each month to a Roth IRA. This fixed schedule eliminates variability in contributions. This makes it easier for individuals to contribute and control their investments.
There are two types of SIPs: self-managed and directed. Self-directed SIPs are simply the schedule you set for yourself, such as contributing to an IRA or through a brokerage account. Directed SIPs typically take the form of mutual funds or employer-sponsored 401 (k) programs, where contributions are pre-established. In both cases, the amount and scale of contributions remain the same.
Systematic investing takes full advantage of compound interest. Regular contributions to capital allow strategies such as cost averaging in dollars and reinvesting dividends. These strategies increase the earning potential of compound accounts.
Benefits of systematic investing
- Regular predetermined contributions keep investors consistent and aware of their contributions. It creates good habits that promote long-term thinking.
- Recurring investments allow for an automatic average cost in dollars. This lowers the total overall average of an investment and increases discretion.
- Recurring principal amount contributions increase the potential for investment mix. The longer the time horizon, the higher the returns.
Disadvantages of systematic investing
- Compulsory contributions can strain day-to-day finances if income is inconsistent or unforeseen expenses arise.
- Purchasing power does not stay the same month after month. As holdings appreciate, static contribution limits mean less and less purchasing power.
- Not as flexible as discretionary investing in when and how to invest. This can mean missing out on opportunities created by market conditions.
Discretionary investment strategy
As the name suggests, discretionary investing is a strategy that does not adhere to any set timeline. It is a more active approach to investing, which sees investors contribute, buy and sell at their discretion. Or, more often, it means have a portfolio manager do it on your behalf.
This approach offers significant flexibility, but comes at the expense of consistency. For those looking for agility and flexibility, there is a great opportunity in discretionary investing. You just need to be confident in your investment thesis and your insight.
Discretionary investing can also refer to the active management of a portfolio. For example, a growth investor may choose to take profits from a long-term stake to buy shares in a new IPO. They make active decisions about how to rebalance a portfolio to take advantage of an opportunity, instead of sticking to a regular defined contribution schedule.
Discretionary investors have to work a little harder to manage their portfolios. But in doing so, they are aware of the opportunities that systematic investors are not. Buy before promising results are announced or sell shares of a cyclical fund at its peak, for example. These opportunities are a great way to maximize ROI outside of a regular contribution cycle.
Benefits of discretionary investing
- Lots of flexibility in when and how to invest. Investors are able to recognize and capitalize on strategic opportunities created by market conditions.
- Contribution amounts may change over time. This facilitates the capitalization of price fluctuations of individual securities.
- There is more purchasing power in lump sum investments. This opens up investment opportunities that may be beyond the reach of investors contributing smaller amounts.
Disadvantages of discretionary investing
- It is more difficult to reduce the average dollar cost with discretionary investing. This, in turn, makes it difficult to take advantage of the dial cycles.
- Inconsistencies in investment contributions make it difficult to develop good habits. As a result, investors might try to time the market instead of investing for the long term.
- Too much control over investments can lead to doubts and frequent rebalancing. Too much activity can trigger losses or unwanted tax events.
Which option is right for you?
If you find solace in consistency and want the assurance of stability, then systematic investment is likely for you. If you are confident in your investing knowledge and have an appetite for risk, discretionary investing could be a lucrative strategy. Either way, it’s important to stick with your approach and make sure that it delivers a return on investment that is above the market.
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Systematic or discretionary investing is a matter of debate among many seasoned investors. There’s no right answer: only the one that’s right for you. It’s best to consider your situation, your hold on investment products, and contribution capabilities before you go down one side or the other. That said, if you don’t know how to invest, a systematic approach is a defensive approach that will serve you well.