When you are considering an investment in a particular sector, you often have to choose between companies that are very similar. How do you pick one? And how do you know that the sector is a solid investment?
One of the key points of investing is to focus on specific sectors, such as mining, banking, food retail and so on. A broad investment psychology would guide one towards the sectors that are more likely to return great profits. Then you would find the best company within that sector. This is called a top-down approach.
Bottom-up investing starts with the theory that a great investment can offer great returns – even if it is within a less-than-ideal sector.
Personally, I always use the top-down approach, rather than the bottom-up approach. There are two key reasons for this.
The first reason is that my ideal holding period is forever. Therefore, I need to be in great growing sectors so that I can stay invested.
If you’re buying bottom-up, the sector may be sub-par and eventually the company you’ve invested in will weaken with the sector. This weakening will mean you’ll need to exit and will leave you having to make the decision about when to sell. Furthermore, you’ll then need to find another investment for the freed-up money.
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6 June 2019