Understanding the difference between top-down investing and bottom-up investing can help you make better decisions about your portfolio. Often, financial advisors use a combination of the two in an attempt to harness the benefits of both approaches.
What is top-down investing?
With top-down investing, you start by looking at the state of the economy and the overall health of stock, bond, currency, and commodities markets. You may also hear this referred to as a macroeconomic (or macro) approach.
While considering the overall health of the economy and markets may seem straightforward, top-down investors tend to pay extra attention to interest rates and current affairs.
Interest rates tend to have an outsized impact on both stocks and bonds. They can also impact the overall economy, in terms of inflation and employment. Macro investors assess how rate hikes or cuts might impact their investment strategy.
Similarly, global events can significantly impact performance. For instance, if war breaks out in an oil-rich part of the world, traders might worry about potential supply shortages, sending energy prices higher. Elections, natural disasters, and even weather patterns can broadly impact large sectors of the economy—so top-down investors may track them in an attempt to improve performance.
What is bottom-up investing?
A bottom-up analysis focuses more on individual investments and pays less attention to the overall economy and market conditions. Bottom-up investors might decide to invest in a stock because they believe the company is building an outstanding product with a great management team, meaning the company may generate value for investors regardless of overall market conditions.
Most discussion of bottom-up analysis focuses on stock picking, but these days, the approach can apply to far more than stocks. For instance, you may decide to invest in a mutual fund because you’ve done extensive research on the fund manager and trust their approach to investing in a variety of market conditions.
As you might expect, there are multiple ways to evaluate the quality of an investment, meaning bottom-up investing can be risky and somewhat subjective. However, this more focused approach can help investors find “diamond in the rough” companies when done well.
Is it better to take a top-down or bottom-up approach?
There are pros and cons to both methods.
The top-down approach can be a great way to understand the global economy. Understanding why, and how, a natural disaster in China might impact a tech company in California can lead to better overall decisions.
At times, macro trends may even outweigh fundamentals in terms of how individual investments perform.
Case in point: Even outstanding companies might see their share prices fall in a recession or in a bear market when investors feel compelled to sell. This is one reason even bottom-up investors tend to keep the big picture in mind.
Understanding broad trends can also help investors evaluate performance. For instance, while some investors may be tempted to change strategies if they experience lower-than-hoped-for returns, it may be better to stay the course if those returns coincide with an economic slump or overall bear market.
One thing to keep in mind, though: It’s impossible to be an expert in everything. Truly excellent bottom-up investors often spend years revising how they evaluate companies; they may even specialize in certain sectors or industries.
A top-down approach can benefit from a similar level of specialization. Often, professional money managers work with teams of analysts that each specialize in different areas, allowing them to step back and evaluate everything as a whole.
Most financial advisors believe in an approach that combines both top-down and bottom-up investing. Even if you have a mainly top-down approach, you still want to look at the fundamentals before investing in a stock or other investment.
At Bogart Wealth, we prefer to start with YOU. We use both top-down and bottom-up strategies to maximize return and minimize risk. Once we understand your goals and timeline, we can help you select an investment portfolio designed to help you get there.
If you have questions about the various approaches to investing or want help evaluating whether your current portfolio aligns with your goals, contact a Bogart Wealth Advisor.
