When it comes to investing, there are two main strategies you can use: top down investing vs bottom up investing.
In a nutshell, top down investing starts with a big-picture analysis of the overall economy, while bottom up investing starts with micro-analyzing individual companies. Both have their own benefits and drawbacks. So, how do you know which strategy is right for you?
In this article, we’ll dive deeper into the differences between top down vs bottom up investing (two investing terms you need to know) and how each of them works. Here we go…
What is a top down investment approach and how does it work?
A top down investment approach is when you start with the big picture and then move down to smaller details. So, this means you'd first look at broad factors like the overall economy, interest rates, and geopolitical events.
From there, you'd then decide which sectors or industries are doing well and invest in those.
Example of top-down investing
Suppose Jenny wants to start investing. She's a complete newbie, so she wants to be as hands-off as possible. She also plans on leaving her money in the stock market for a long time. So, all she’s looking for is a quick way to diversify her portfolio so she can get started investing now.
So, Jenny goes with the top down investment approach.
Instead of combing through thousands of individual stocks and securities to see which ones are best (which sounds like Jenny’s worst nightmare), she decides to invest in three exchange-traded funds (ETFs) that blanket several economies and sectors. So, she invests in one U.S. stocks ETF, one U.S. bonds ETF, and one ETF made up of international stocks.
With just these three funds, Jenny has quickly built an instantly diversified, low-cost 3 fund portfolio. She focused on macro-factors only, without getting too into the weeds. As a result, now all she needs to do is rebalance her portfolio every once in a while.
Pros and cons of the top down investment approach
Top-down investing is a great choice for women who don’t want to sink a ton of time into researching individual stocks and companies.
Pros of top down investing vs bottom up investing
When it comes to top down vs bottom up investing, the top down investment approach has these benefits:
You can potentially make more money
With this method, you’re looking at the big picture. You’re not just buying a stock because it looks good on paper or because everyone is talking about it.
You’re trying to find stocks that will do well in the long run based on factors like the overall economy, interest rates, and political factors. And because you're not putting all your eggs in one basket, you have the potential to make potentially higher returns over the long term.
You can get a better understanding of the market
When you take a top down investment approach, you’re looking at the entire market. This gives you a better understanding of how it works and what drives it. You can then use this knowledge to make more informed investment decisions.
It’s easier to stay disciplined with top down vs bottom up investing
When you have a top-down investing strategy, it’s easier to stick to your plan. This is because you already have an idea of where you want to invest and what stocks fit into your overall plan. You don’t need to worry about being swayed by the latest stock tips or news stories.
You can still invest in individual stocks
Just because you’re taking a top down vs bottom up investing approach doesn’t mean you can’t invest in individual stocks. You can still do your own stock research on companies and pick the ones you think have the most potential. You just need to make sure they fit in with your overall investment plan.
Cons of top-down investing vs bottom up investing
All that said, top-down investing has a few drawbacks:
You can miss out on good opportunities
When you’re only looking at the big picture, you might miss out on some good opportunities. For example, if a small company is doing well but doesn’t fit into your overall investment strategy, you might miss out on potential profits.
You need to have a good understanding of the market
If you want to be successful with a top-down investing approach, you need to have a good understanding of how the market works as a whole. This can be difficult for some people, especially if you’re just starting out.
What is a bottom up investment approach and how does it work?
A bottom up investment approach starts with analyzing individual companies and their prospects. The goal is to find the best investments in each sector, regardless of what is happening in the overall market.
This strategy is popular among investors who are looking for opportunities to beat the market. Because bottom up investing starts with analyzing individual companies, it can help you find investments that may be undervalued by the market.
However, this approach can also be risky. If you invest in a company that fails, you could lose a lot of money.
Example of bottom up investing
She’s also dabbled in short-term trading, trying to capitalize on quick wins in the market. She’s not afraid of a little risk, and she’s comfortable in her stock market experience.
Because of this, Carla is more into bottom up investing. She wants to know everything she can about the companies that make up her portfolio, and she’ll stop at nothing to gain all the fundamentals she needs to succeed.
Pros and cons of the bottom up investment approach
Bottom up investing is best for data-driven women who want to have full control over which companies they're investing in and why.
Pros of bottom up investing
When it comes to top down vs. bottom up investing, the bottom up investment approach has these benefits:
You can find good opportunities
With a bottom-up approach, you’re looking at individual stocks. This gives you the opportunity to find good investments that might not be as well known. You can also take advantage of price fluctuations to make a profit.
You can invest in any type of stock with top down vs bottom up investing
Unlike a top-down approach, you don’t need to stick to certain types of stocks when using a bottom-up strategy. You can invest in small or large companies, growth or value stocks, alternative assets like REITs and cryptocurrency. This gives you a lot of flexibility when it comes to investing.
You don’t need to have as much knowledge about the market
With a bottom-up approach, you’re focused on individual stocks rather than the overall market. This means you don’t need to have as much knowledge about the market in order to be successful.
Cons of bottom up investing
That said, there are some obvious drawbacks to the bottom up investment approach:
You might not make as much money
With a bottom-up approach, you’re not necessarily looking at the big picture. This means you might miss out on some opportunities for growth. For example, if the overall market is doing well but the individual companies you selected aren't, you might not make as much money.
You need to do your own research
When you’re investing in individual stocks, you need to do your own research to find the best opportunities. This can be time-consuming and difficult if you're not familiar with the process.
You might not be as diversified
If you’re only investing in individual stocks, you might not be as diversified as you could be. This means you could be taking on more risk than necessary, which Investopedia says is one of the biggest problems with bottom up investing.
It's easy to overexpose your portfolio to risk when you're purely looking at which assets may perform the best.
Top down vs bottom up investing: Which should you choose?
So, out of top down vs bottom up investing, which strategy is right for you? Like most things in life, there is no one-size-fits-all answer. It depends on your wealth accumulation goals and risk tolerance.
If you are looking for stability and consistent growth (with as little portfolio maintenance as possible), top-down investing may be a good option for you. If you are looking for opportunities to beat the market and get a better grasp on the fundamentals, bottom up investing may be a good fit.
In some cases, you may want to do a mix of both strategies at the same time. For example, say 95% of your portfolio is in index funds, but you’re also interested in trading cryptocurrency. So, you use the other 5% of your portfolio to invest in a few cryptocurrencies you think could grow in the short term.
In this instance, you’re using a top down investment approach with your index funds, and a bottom-up approach with your cryptocurrency.
FAQs about top down vs bottom up investing
Which questions do you have about top down vs bottom up investing? Some big ones we've seen are:
What is the difference between top down vs bottom up investing?
Top-down investing starts with an analysis of the overall economy, while bottom up investing starts with analyzing individual companies. Top-down investing can be risky if the overall market conditions change, while bottom up investing can be risky if you invest in a company that fails.
Is Warren Buffett a bottom-up investor?
Yes, Warren Buffet is a bottom-up investor. He is known for his in-depth analysis of individual companies. Even from an early age, he found that there's value in investing in a few strong companies regardless of how the sector they're in is doing. This, in a nutshell, is what bottom up investing is all about.
Is top-down investing more risky than bottom up investing?
It depends on the specific approach. Top-down investing can be more risky if the overall market conditions change. Bottom up investing can be more risky if you invest in a company that fails. Good investing is all about striking the right balance between risk and being able to sleep soundly at night.
Can I use both top down vs bottom up investing at the same time?
Yes, you can use both top-down and bottom up investing strategies at the same time. This can be a good option if you want to have some stability while also looking for opportunities to beat the market.
What should I do if I'm not sure which type of investing is right for me?
No matter which type of investing you choose, make sure to do your research and always stay informed about what is happening in the market! You can also speak to a financial advisor to get more information about which approach would be best for you.
What’s the best way to do bottom-up research?
The best way to do bottom-up research is by analyzing individual companies and their prospects. This can include looking at financial statements, studying industry trends, and talking to experts in the field. You should also look for companies that could be undervalued by the market.
What’s the best way to do top-down research?
The best way to do top-down research is by looking at the overall economy and then moving down to specific sectors and companies. This can include looking at GDP growth, studying industry trends, and talking to experts in the field.
Top down vs bottom up investing: The bottom line
In conclusion, top-down investing vs. bottom up investing are two different strategies you can use when building your portfolio. One strategy isn’t better than the other.
It ultimately depends on the type of investor you want to be and how much time you want to pour into diversifying your portfolio. And in some cases, you may even want to use both strategies at the same time.
If you're looking for more information on investing, be sure to check out the second Clever Girl Finance book "Learn how investing works, grow your money!" and also take one of our FREE investing courses!