Asked on 25 Feb 2019
Top down investing focuses on macroeconomic factors. So an investor might look at countries with the highest growth rates or growth potential, followed by that of the industries and then start to select stocks from there.
They may also pay more attention to economic cycles. Since they are focused on more broad economic trends, many of them tend to be focused on economic trends than individual performance of stocks. They try to take advantage of such broad trends using ETFs. An advantage is that these investors may tend to benefit from a more diversified portfolio within a certain sector or industry. However, a disadvantage could be that the composition of the portfolio is not properly controlled where it is not diversified across uncorrelated secotrs.
Bottom-up approach would focus their analysis on individual companies and then build a portfolio from there. They will probably do in-depth research and analysis on each company and try to find which stocks are undervalued or a good buy to add to their portfolio. An advantage that they have is that their portfolios can be quite well diversified across different industries. A disadvantage is that they need to look for the right attributes and cover enough grounds sufficiently to succeed in the long run.
Hello, personally I would not say that there is a better approach as I find that it is essential to engage in both ways in order to be able to reap the best outcome.
Top-down investment is more for those who are interested in the macroeconomic environment, such as looking at the outlook of the country. While bottom up investment would be looking at the specific companies. For me, I feel that it is essential to look both ways in order to make the best decision on which stock or what to invest in.
Personally, I prefer bottom-up investing. I found that with bottom up investing, I make lesser mistakes due to the predictive nature of top-down approach. The bottom-up approach also requires less information to reach the same decision as the top-down approach. Topdown investors are ultimately trying to time to market, which not only requires them to make a judgement of the overall market direction but also know when to sell stocks. They are faced with alot of uncertainty. For myself, the bottom up approach forces me to be clear about my initial reason for buying the stock. This comes in handy when I have to decide whether to sell or hold when the stock value appreciates or depreciates.
I think both approaches work. I myself practice both of them.
For example, when I bought into cybersecurity stocks, it was because I first identified and liked the macros of the industry- the growth and promise of cybersecurity in general, before I researched more into individual companies.
There have also been other instances where I chanced upon companies from various news sources and evaluated their business model bottom up before deciding it was worth investing in. Proponents of bottom up often argue that it gives more accurate future projections for the company, but I believe both methods carry their own assumptions, and as long as you can understand and reconciliate these differences, both are equally viable.