Markets & Strategies

Investment Strategies: Top-Down and Bottom-Up Investing

Top-down and bottom-up investment strategies may help you maintain a balanced, diversified portfolio.

by Rachel Hartman - July 10, 2017

When it comes to which investment strategies to employ, people generally fall into two camps: “top-down investing” or “bottom-up investing.” While both investment strategies have merits and drawbacks, incorporating them in tandem may help you achieve a balanced, diversified portfolio.

But first, what are top-down investing and bottom-up investing?

  • Top-down investing: Focusing on broad economic sectors to determine which may benefit from current and anticipated economic conditions.
  • Bottom-up investing: Evaluating companies based on their brand and product strength, regardless of what the market is doing.

Understanding top-down investing

A top-down investing strategy begins by looking at key economic factors, such as GDP, inflation, and interest rates. “You’re looking more at macroeconomic benefits and weaknesses,” explains Scott Wren, Senior Global Equity Strategist for Wells Fargo Investment Institute.

An investor employing this investment strategy will use this big-picture knowledge to select a promising country or region, and then analyze industries and sectors within that area. Once they find a favorable sector, they’ll select attractive companies operating in that field.

With this strategy, it’s important to look at “where the economy is going, and which sectors and companies are going to benefit from where the economy is going,” says Wren. For example, when consumer confidence is higher and people are likely willing to spend more on furniture and other nonessential items, sectors such as Consumer Discretionary tend to perform better.

One advantage of top-down investing is that having a focus on the economy’s performance allows you to understand more about how individual companies operate. “[Corporate] earnings are a product of the economic environment,” says Wren. And corporate earnings typically have a significant impact on a company’s stock price.

While both investment strategies have merits and drawbacks, incorporating them in tandem may help you achieve a balanced, diversified portfolio.

Understanding bottom-up investing

A bottom-up investing strategy begins on the other end of the spectrum. Rather than surveying the global environment, investors start with individual companies. They may study the company’s balance sheet, income statement, or reports to learn its strengths, weaknesses, and overall financial stability. Once they find a strong option with solid prospects compared to others in its niche, they will invest in the company.

A potential drawback to the bottom-up investing strategy, however, lies in the risk of overlooking macroeconomic factors. Investors taking the bottom-up approach may not focus on the environment the company is going to be operating in, explains Wren. A great company could have a solid balance sheet and income statement, but if it enters an environment that is not ideal for its growth and performance, its bottom line could suffer.

Finding a balance

When it comes to investing, “the ideal situation is to have some combination of top-down and bottom-up investment strategies,” says Wren.

It’s good, on the one hand, to understand an individual company before investing in it. By understanding its financial reports, you increase your knowledge of whether or not the firm is in a solid financial position or if it has a lot of debt relative to its peers.

At the same time, having an understanding of where the economy is going is key, adds Wren. Some companies are more sensitive to changes in the environment than others. Utility stocks, for instance, might remain stable in a down economy. “You’ll heat your home whether the economy is good or bad,” says Wren.

Discuss these two investment strategies with your Financial Advisor, who can put them in the context of your overall portfolio and provide advice and guidance about areas of opportunity and how you may need to adjust your strategy based on economic conditions.

Rachel Hartman is a freelance writer who covers small business and personal finance topics. Her credits include Industry Today, MyBusiness Magazine, Bankrate.com, InsuranceQuotes.com, and many others.

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Additional Resources

Inflation is a key economic factor that can impact your investments. Is your portfolio prepared for rising inflation rates?

 

Risk Factors

All investing involves risks including the possible loss of principal. Equity securities are subject to market risk which means their value may fluctuate in response to general economic and market conditions and the perception of individual issuers. Investments in equity securities are generally more volatile than other types of securities.

Disclaimers

Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly-owned subsidiary of Wells Fargo & Company.

The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client‐specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon.

Wells Fargo Advisors is registered with the U.S. Securities and Exchange Commission and the Financial Industry Regulatory Authority, but is not licensed or registered with any financial services regulatory authority outside of the U.S.  Non-U.S. residents who maintain U.S.-based financial services account(s) with Wells Fargo Advisors may not be afforded certain protections conferred by legislation and regulations in their country of residence in respect of any investments, investment transactions or communications made with Wells Fargo Advisors.