Your Investment Approach: Top-Down or Bottom-Up, or Somewhere in Between?
A top-down approach; what do we mean with that? Image you are to design a portfolio management system that automatically updates an investment portfolio. New stocks are automatically selected, some stocks in the portfolio are replaced by others and some are sold without an additional following up. Before any decision to buy or sell you need to do some analysis. One way would be to analyse the pool of available shares (focused on whatever stock exchange) and for each share you could define a selection indicator. You then prioritize (sort) these available stocks in decreasing order; the stock with the highest potential will appear on the top, which is the first to be bought. In line with this algorithm you check your existing portfolio and those stocks with a lower potential should become available for a Sell advice. This is a bottom-up approach, a very transparent way of selecting stock for a portfolio. Another way would be to analyse the stock market is a whole and to start with a formulation of an investment allocation. This is a kind of mix that represents the market condition of the moment. In a positive market climate – for which you have setup a investment model – you would fully allocate your portfolio with stocks. When conditions worsen you decrease the allocation to a minor percentage of stock in portfolio. This already gives some guidance for your portfolio management system, but you need to enhance this a more detailed approach in which you select those stock for the percentage that you have allocated. Each approach has interesting features. The bottom-up way is transparent and the best way to discard emotions from the investment process; there is always a stock to buy… But it costs a lot of time to trace the development of all those individual shares. The top-down is also charming; if you have found a basic allocation mechanism, you will have less work in managing and updating the portfolio. There is a risk however that the allocation is done on emotional bases. Although you need less information about the market, you will probably need more knowledge to get the allocation right. And then there is of course the combination of both world; a top-down approach, that you complement with a bottom-up way of selecting stock for that percentage that you have previously defined (allocated). An additional challenge is to keep both investment styles separated, that is if you are serious about it. © 2006 Hans Bool Hans Bool is the founder of Astor White a traditional management consulting company that offers online management tools. Have a look at some of our free management tools |
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