Question

What are some advantages and disadvantages of top-down versus bottom-up investing styles? Explain with examples.

Answer 1

Top-down investing is also known as macro-investing. The investor looks at the overall economic outlook and chooses sectors. For example investor after careful research may select IT sector and within IT sector he decides to invest in Microsoft or intel shares. Another example can be of Automobile sector where he decides to invest in general motors shares or ford shares. Also Selecting emerging markets like India, china and brazil and then investing there like investing in these countries company shares or directly opening showrooms there is also a part of top down investing. For example Mcdonalds or coca cola opening their stores in india or china to capture oppourtunities of a larget market as population of these two counties is the highest in the world.

Bottom up investing is Asset picking. The investor chooses a company because of the company’s financial position and not the outlook of the sector to which this company belongs or the outlook of the general economy. For example An investor may decide to invest in Google as it is expected to launch its laptops and TVs in the world market to challenge existing players market shares. Here investor does not look how other laptop players and TV producing players are performing or how the industry has been performing as he has confidence that google is top brand and its entry into these segments would bring good results and hence its profits would go up and as a consequence share price would go up.

Advantages and disadvantages of top down investing

Advantages

• Time saving: As you start with a broader look, you can reuse the broader information to make other investments.

• Risk Control: Top-Down approach is generally adopted by long term and risk averse investors and generally avoids volatile, sensitive stocks

Disadvantages

• Complex and Time Consuming: As Top Down approach needs detailed study of broader terms, extensive and detailed study is necessary before making investments. Generally, retail investors find it difficult due to lack of expertise and resources.

• Doesn’t work in bear markets: The top-down approach only works in bull markets and investors generally don’t adopt the approach in bear markets. (Bull is rising markets and bear is falling markets)

​Advantages and Disadvantages of Bottom Down approach

Advanatges

• Less complex and time consuming: As the process doesn’t need extensive study and research, the process is easy for retail investors.

• Good for seasoned investors: Investors with good sense of short term investment opportunities who generally know how to invest for a short term adopt bottom up approach.

Disadvantages

• Not good for new or unexperienced investors: Investors with little experience find it difficult to shortlist a company to invest in for a short term perspective.

• More risk: Bottom up approach is exposed to more risk as no extensive study is done to make investments.