Advantages and Disadvantages of a Mechanical Investing Strategy
Mechanical investing is the buying and selling of stocks (or other securities) by following a pre-determined, objective set of rules that determine which stocks to buy and, under some approaches, when to sell them. Mechanical investing strategies often employ the use of stock screeners or technical indicators to take the emotional element of the decision process, focusing instead on historical data, trends, and strategies that have proven to be effective in the past.
Dogs of the Dow: An Example of a Mechanical Investing Strategy
With the Dogs of the Dow strategy, the investor looks to buy high-quality companies that have fallen temporarily out of favor. Under this approach, the ten Dow Jones Industrial Average (DJIA) stocks paying the highest dividend yield are selected for investment and held for the next twelve months, at which time the list is re-visited and the portfolio is adjusted accordingly. The idea is that, during the one year holding period, the market will recognize the true value of the Dog stocks and the prices will adjust upward.
Advantages of a Mechanical Investing Strategy
Low Cost: Most mechanical investing strategies call for very low turnover of stocks, keeping commission fees low.
Minimal Time Commitment: Mechanical investing strategies to not require investors to spend a great deal of time analyzing stocks and managing portfolios. Stock screeners and other tools enable quick selection of stocks based on the individual’s investment criteria.
Takes the Emotion Out of Investing: Mechanical investors have the benefit of taking both fear and greed out of their investment decisions focusing; instead on a pre-set strategy to determine stock selection and the timing or purchase and sale.
Disadvantages of a Mechanical Investing Strategy
Investing Based on Past Results: Mechanical investors count of future results based on what has happened in the past. Markets, being dynamic, have a good deal of unpredictability.
Little Familiarity with the Selected Companies for Investment: Because a mechanical strategy is purely objective, investors may be taken out of their circle of competence, potentially investing in companies and industries they do not know very well.
Lack of Flexibility: When investors truly stick to a mechanical investing strategy, they lose the opportunity to take advantage of investment opportunities that present themselves that, based on the investor’s instincts, would seem to present a good opportunity.
_______________________________________________________________
The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.
Recent Posts
- How to Calculate a Stock Market Profit
- Three Basic Financial Concepts for Investors
- Understand an Calculate the Capital Asset Pricing Model (CAPM)
- Calculate Your Retirement Savings Requirements
- The Basics of Stock Market Futures Trading
- How to Calculate Internal Rate of Return (IRR)
- How to Calculate Earnings per Share
- What the Par Value of a Stock Means
- Bond Value Calculator
- Some Basic Forex Trading Tips
Leave a Comment
You must be logged in to post a comment.