Investing > Complete Guide to Top-Down Investing

Complete Guide to Top-Down Investing

Different roads can lead to the same destination. Read on to see how we can apply this to investing.

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Updated July 08, 2022

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When it comes to investing, different strokes work for different folks.

The reality is finding a starting point for investing is one of the most challenging parts of investing. If you’re looking for a relatively “easier” way to enter investing, the top-down method could be for you. 🤓

A top-down approach to investing is debatably easier than a bottom-up approach. Instead of analyzing a company piece by piece, many top-down investors look at mostly major economic factors before making their decision on where to invest. They will also tend to invest in multiple companies at the same time, adding natural diversity to their portfolio.

Chintan Haria is a top-down investor who launched a top-down-based investment fund that focuses on India’s real estate market. This fund allows investors who see the potential in the Indian real estate market to have a starting point to invest. Chintan Haria started this after he noticed a 2.1% increase in housing prices in India in 2021 meaning that investors in his fund could gain a similar return if they invest and the trend continues.

It isn’t always sunshine and rainbows in top-down investing, however, because when an investor forgoes researching individual companies, as is typically done in a top-down approach, they could not only miss out on an investment in a great company but their portfolio could be damaged by an investment in a bad company. Therefore all top-down investments need to be made with care. 

Think top-down investing may be the right approach for your portfolio? Then keep reading, as we will walk you through all the aspects of top-down investing so you can be sure it is the right investment strategy before you begin. 🎯

What you’ll learn
  • What is Top-Down Investing?
  • Factors to Consider in a Top-Down Analysis
  • Why Do Investors Opt for Top-Down Investing?
  • How Does Top-Down Investing Work?
  • Example of Top-Down Investing
  • Advantages of Top-Down Investing
  • Disadvantages of Top-Down Investing
  • Bottom-Up vs. Top-Down Investing
  • Should You Consider Top-Down Investing?
  • Conclusion
  • FAQs
  • Get Started with a Stock Broker

What Exactly is Top-Down Investing? 📚

Top-down investing is an investment approach that focuses on the macroeconomic factors of the economy –  e.g. GDP, taxation, interest rates, etc. – before narrowing down to micro factors like specific sectors or companies.

We can think of this investment approach like a funnel, studying the broader view of the market, working down and narrowing our focus to potential sectors and industries, and individual companies before deciding on where to invest.

Sometimes an investor may not want to follow the funnel all the way down to a single company. In fact, they may stop their top-down research after identifying a sector they’re interested in. As a result, many top-down investors open positions that contain ETFs or other index funds.

Top-down investing doesn’t explicitly mean that an investor has to open a position on an index-type fund, as some people do use the top-down investment strategy to narrow their investment down to a single company. This is less likely, however, as most top-down investors prefer to stop their research long before that time. 

For example, a top-down investor may see a news article that index prices are soaring in Hong Kong. The investor will then look at the GDP of that country, as well as the specific indexes which are soaring. In this case, it is the technology stocks that are experiencing a boom, so the investor would likely open a position in Hong Kong technology stocks based on his or her top-down analysis.

Factors to Consider in a Top-Down Analysis

Of course, top-down analysis isn’t always this easy or this brief, but it is less in-depth than comparable forms of investing such as bottom-up investing or buy-and-hold investing. This is because top-down investors only look at large trends, and make investments that typically involve more than one company–which lowers their overall risk. 

Below are some of the common factors top-down investors must consider before placing an investment. 

Global Factors 🌐

A top-down investor usually starts their investing by looking at global factors like wars, embargoes, and economic trends of an entire country. Global factors tend to affect entire countries and can help direct a top-down investor to a country they should make an investment in.

For example, in February 2022, a war broke out between Ukraine and Russia. As a result of this war, many people relocated, and many supply lines were disrupted.  Because these disruptions  affected the Ukrainian economy, an investment in a company based in the country would be a bad idea. Additionally, a top-down investor would want to ensure their sector was not based in this country as this could cause the entire sector to take a dip. 

But just because Russia was on the other side of the war doesn’t mean an investment in a Russian company or sector based in Russia is a good idea either. Global perception can have a huge effect on the economy of a nation. This was further confirmed when the U.S. imposed banking sanctions on Russia, meaning an investment within the country would be impossible.

Instead, the investor may decide to look for an investment a little closer to home, say the U.S. if the investor is American. A more local investment would be safer because of the way the war front continues to change on a day-to-day basis. 

Macro Trends 📊

Besides global factors, a top-down investor also needs to be aware of macro-trends. Macro-trends are large shifts in consumer spending in a certain sector based on what is currently considered valuable to consumers. 

For example, consumers shifting from going out to work out in a gym, to working out with equipment at home instead, is a macroeconomic shift in the work-out industry. So an investor in this industry may decide to choose an investment in companies that create workout equipment rather than in companies that run gyms. 

In 2022, following the COVID19 pandemic, many people have begun working from home full time. Additionally, most people who were trapped at home for months, discovered the magic of online ordering and continue to order groceries to be delivered to their homes rather than go to the grocery store.

But this trend didn’t just affect the grocery stores. It also caused many individuals to shift to ordering almost everything to delivery, as during the pandemic, they had to. And once they realized how convenient it was, they continued to order online, even when some people returned to the office after the beginning of the pandemic.

This trend of spending more time at home and less time out and about buying groceries or shopping for goods is a macro trend because it affects numerous industries in several different sectors. It also represents a complete change of life that investors need to be aware of (for example, an investment in a brick and mortar store that sells goods but doesn’t offer delivery is probably not a good idea based on this macro trend.)

Sector Analysis 🔍

Once a top-down investor is aware of macro-trends going on in the world, then he or she would look at a particular sector to invest in. They would typically look for sectors that are undervalued or experiencing massive growth.

In 2021, the housing market was up all the way around the world. Whether an individual lived in Hong Kong, India, or the U.S., housing prices were up 15% across the board. A top-down investor may take note of this and decide to place their investment in the real estate market.

This could look like selecting a country, analyzing the available real-estate ETFs and index funds, then moving to invest. While this sounds like a simple, straightforward process, it’s important to note that investors will spend time thoroughly analyzing potential stocks before investing.

Stock Comparison ⚖

Sometimes, top-down investors will compare individual stock offerings before they place their investment. Unlike other types of investing, this comparison is typically between company offerings rather than company against company. 

Think of it this way, a top-down investor will rarely compare one company’s stocks to another company’s stocks, but rather they will look at the company offering the stocks. In continuing with the above example, if an investor chooses to invest in U.S. real estate stocks, they may choose between choosing the Real Estate ETF offered by Vanguard or the Real Estate ETF offered by Fidelity Investments.

The reason the analysis doesn’t always get this deep is that investors typically have a dependable stock broker they are already using, and they will normally just invest in the options on there. Not to mention that when investing overseas, the options can frequently be limited based on their country of residence–meaning an investor may not have much choice on what platforms they use to invest in the particular sector they are interested in abroad.

Why Do Investors Opt for Top-Down Investing? 🧐

There are several reasons an investor opts for top-down investing, namely because it offers a broader, less intricate, approach to investing. Rather than looking at local companies that the investor might know, he or she is looking at investment possibilities all over the world that may not be available in his or her local country

For example oil is a global stock that is typically offered only internationally. If an investor wants to get involved in the oil industry a top-down approach to investing is absolutely critical, as macro trends must be investigated in order to make a wise investment decision, as this sector is heavily influenced by wars, import taxes, and demand. 

This gives the investor more choices with where to invest funds, as well as more potential for returns. Plus, unlike bottom-up investing, most top-down investing methods involve placing money in more diverse investments, such as ETFs which are a collection of many companies as many investors end their research prior to reaching a single company and instead choose to focus on a sector. 

Diversity with a broad range of options is typically less risky than investing in a single company–as if one company fails an investor likely won’t lose their entire investment. And all of this can be done without intricate knowledge of how the stock market works, as some of the information can be found on a local news channel, and then the investor only has to do some basic research before making an investment decision. 

Thus, top-down investing is a preferred choice by those new to investing. They get to expose themselves to a small level of risk in stocks all over the world–without having to know everything there is to know about the financial world. 

Top-Down Investing: How Does it Work? 🏗

It’s important to understand the fundamentals of top-down investing before adopting it as a strategy. This allows investors to make the best decisions when it comes to selecting their investments.

With top-down investing, there is a very specific method that most investors follow. While every individual doesn’t have to follow this method all the way to the end, all top-down investors do start out the same way–it’s what makes them top-down investors. Take a look at the diagram below. 

Diagram depicting the period of priority when it comes to top-down investing. Investors start with macro factors, then a sector, and finally, selecting a firm.
In top-down investing, an investor will consider macroeconomic factors first, before choosing a sector and company to invest in.

A little confused? We will break each step down below. 

Selecting a Country 🌍

Because top-down investing opens an individual to investments in countries all over the world, it’s important to start by selecting a country to invest in. Keep in mind that some countries might look favorable on paper, they may not be a good investment in reality.

For example, an investment in the Indian real estate market may look like it garnishes great returns at 5%. But when the native currency is converted, in this case, the Rupee, to USD not only is the monetary amount made much smaller but, also, the investor will pay fees in order to convert the currency–and this can take a large chunk out of the potential return.

A single Indian Rupee is only 0.013USD. Therefore if an investor gained a return of 300 Indian Rupees may sound great, but it is only $3, and then once fees are paid to convert that, the investor will likely only break even. 

This works in the other direction, however, especially if an investor becomes involved in a market like the UK or Europe as the exchange rates in those countries are actually in their favor. Just keep this in mind while selecting countries to invest in.  

When selecting a country for a top-down investment, investors look at markers such as the GDP, investment options within the country, and political restrictions to investing there. It can also be helpful to watch the news to ensure there are no conflicts in the country that could hinder investment returns. 

Selecting the Right Sector 🎯

After an investor has picked a country it’s time to pick the sector. Oftentimes this will be an easy step, as most investors will likely have selected the country with the sector in mind–as it would be odd to choose to invest in a country like China when interested in cryptocurrency stocks.

But, if an investor for some reason didn’t have an idea, now is the time to shop around a bit for the specific offerings of that sector within that country. This can be helpful in many situations where an investor’s home country may not allow an investment in that particular sector where they live. 

The investor will then consider many factors, such as how the economy in the country will affect the sector they have chosen. They may also take a look at local news sites to find out how the locals feel about that sector. For example, it would be a bad idea to invest in sugar cane crops based in a country where the locals hate sugar cane crops and plan to burn the fields. 

Look at this example, in the Netherlands, there are many strict housing requirements, especially when it comes to building new homes, which makes it difficult for the real estate market to grow. For this reason, many Dutch investors choose to use top-down investing to gain exposure to real estate stocks somewhere else, such as in India, or the U.S., as these markets offer them better returns.

Selecting an Asset 🗃

Sometimes, after selecting a sector, an investor may be done with his or her analysis, as the asset desired may be the only one available. For example, if the investor wants to invest in oil stocks, there isn’t any other commodity in the oil market other than oil.  This is especially true when an American invests abroad as there are very few platforms that allow Americans to invest internationally. 

But, if an investor has chosen a sector to invest in that is close to home, they will likely have many assets to choose from. Now, this doesn’t mean they will be selecting a particular company (although some investors do) but rather they are selecting the asset they want to put money into.

In many cases, this asset is an ETF in the desired investment sector. So if an investor would like to invest in technology, they would likely choose a technology ETF or Index fund. But sometimes there are other options available, such as bonds, or trading the international currency itself through forex trading.

Many top-down investors end up choosing to invest in an ETF because they are seen as carrying lower risk. This is because an ETF is a mix of different companies rather than just one. Thus allowing the investor to diversify with a single asset purchase. And if one company happens to go under, the investor will not lose their entire investment. 

Occasionally, the sector someone is interested in may only have a few companies, which is where they may decide to narrow their asset down to holding stock in one company. This is the case with consumer product delivery, as in the US, this sector only contains the USPS, UPS, FedEx, and Amazon, so a top-down investor may choose to invest in one of these companies at the asset level rather than an ETF option. 

An Example of Top-Down Investing 📝 

Understand the basics of top-down investing? Just to be sure, we will go through an example of how it would work. 

Jane is a top-down investor, and she is interested in consumer staples, as she believes this is a stock that will always be growing, even during a recession. Consumer staples are things like food, beverages, tobacco, shampoo, and cleaning products. Typically consumer staples stocks are inelastic because people will continue to use them even when the market takes a dip.

For example, when the COVID19 pandemic hit, people still needed to buy the basics, even when they were stuck at home while other stocks like oil and entertainment took a huge dip. Jane knows this because she saw on the news all about the shortage of cleaning products and toilet paper during the pandemic. 

After deciding she wants to invest in consumer staples, Jane will then look at which country has a good record of a high GDP in consumer staples. She may also look at the country which has the most consumer spending annually

As she looks at the list, she realizes the top 4 performing countries are the USA, UK, Belgium, and the Netherlands, in that order. Jane isn’t opposed to investing internationally, but the USA is just so far above the other two, she decides to stick with investing close to home. 

Jane already has an account on a stockbroker platform, and when she checks it, they have a consumer staples ETF.  She decides it is best to diversify with an ETF rather than continue her top-down analysis. She buys a few shares, and just like that her top-down investing is done. 

Advantages of Top-Down Investing 🌟

As one can see from Jane’s story, there are several advantages to top-down investing that aren’t available with other types of investing. We will cover a few of the most important here. 

Top-Down Investors Have Their Choice of Assets 🧾

Top-down investing truly allows investors to access the world with investing. Because top-down investing typically starts at macro-trends or GDP, it really is possible to invest in any country in the world. 

This allows a top-down investor to have access to products or industries that aren’t prevalent in the country where the investor lives. Many investors use this benefit to take advantage of trading forex pairs–also known as trading foreign currency.

Additionally, this allows many investors to get involved in foreign markets that may be just beginning. Giving them a chance to purchase an early investment in a market that may have already taken off at home. 

Diversification 📃

One of the best ways to manage risk while investing is through diversification. Top-down investing is naturally diverse.

This is because many top-down investors don’t get down to the nitty-gritty point of choosing a single company. Rather they typically put their money into a specific sector via an ETF or other index option. So if one of the companies in an ETF a top-down investor is invested in goes under, he or she doesn’t have to panic as they will likely still earn a return on their investment. 

Additionally, if the investor is living somewhere where there are economic or political problems, top-down investing allows them the diversification to have assets outside their country. This can protect them if the problems within their country begin to get serious. 

It’s Good for Beginners 👨‍🏫

Were you able to easily follow how Jane from above came to her top-down investing conclusion? This is because there is very little math involved in top-down investing analysis, and the math and analysis that is involved is easy for a beginner to follow. 

For example, many other types of investing require looking at charts and knowing how to read the line movement on the chart. Some types of investing also involve looking at financials and P/E ratios. Top-down investing, on the other hand, usually starts with watching the news or reading the media from a certain country. Then the investor will look at the GDP as a whole, or maybe of just a particular sector in that country.

Because many people have watched or read the news their entire life, they find the macro-trend analysis much easier to perform as it is less technical. Investors also find the GDP is much easier to read and analyze than other numbers used in stock analysis. 

Top-down trading also tends to end in an ETF or bond investment, which isn’t an investment that needs to be checked on each and every day. It is more of a long-term investment plan, meaning once an investor discovers what ETF they want to invest in, it can typically be purchased and only checked on if the investor wants to make a change.

This method has much less stress and analysis than day trading or swing trading which requires looking at charts, performance numbers, and learning to anticipate when a swing may be coming. Additionally, the above methods require frequent portfolio changes in order to be successful.

Disadvantages of Top-Down Investing 🚧

Top-down investing isn’t all fun and games, however, as it is still risky and it does have its downsides. Below we have analyzed some of the major downsides of this style of investing. Ultimately it is up to the investor to decide if the downsides outweigh the advantages of top-down investing.

Investors Are Dependent on Foreign Policy 📄

With top-down investing because research starts on a global scale and then is narrowed down to an asset–a strategy that could be later compromised due to foreign policy changes. Countries are always changing their policies when it comes to markets and investing, and an investor can never predict when an investment could be compromised. 

Imagine an American investor in 2015 who decides to invest in foreign technology stocks, more specifically in Russia, as they have a booming market. They then place a very large investment in ETFs through a foreign investing site. 

In February 2022, their whole world comes crashing down as SWIFT puts banking sanctions on Russia. Now, the same investor has to rush to withdraw the investment before it is too late. But as they are rushing to withdraw their investment, so are many other foreign investors, and it is likely the price will fall, causing them to eventually sell at a loss.

Because it is impossible to predict things like wars and economic crises, this is one disadvantage of top-down trading that cannot be mitigated. Unless you have a crystal ball to share?

Top-Down Investing is Generalizing Performance 🧮

Unlike a bottom-up investor, which knows all the inner workings of their company, a top-down investment approach looks only at broad factors before placing an investment, and this can be dangerous. 

For example, say an investor in January 2020 is thinking of investing in the entertainment industry, after all, it was booming! Said investors would then be shocked to discover that in March 2020, when the global pandemic hit, they would likely lose their entire investment due to said pandemic.

Of course, this event doesn’t just affect top-down investors, but top-down investors have no idea if they are investing in companies that can weather trials and adapt during a global pandemic. They simply don’t search out this information–it’s part of their less complex approach to investing and can’t be changed without switching strategies. 

Bottom-Up vs. Top-Down Investing ⚔

Above, we mentioned how bottom-up investing is the exact opposite of top-down investing. Rather than investigating broad macroeconomic factors, investing from the bottom-up typically starts with a product or service that appears valuable, and then analyzing other factors from a higher level.

Bottom-up investing is like top-down investing in that an investor doesn’t need to do hours upon hours of continual research to get started. But for the research which is required, bottom-up investing requires a little more financial knowledge. This is because bottom-up investors look at metrics like the P/E ratio to try and find an undervalued company. They may also look at company financial reports for additional information.

With top-down investing, the approach is more generalized because investors in this strategy will be looking at the news, and larger, easier to interpret numbers like GDP, and they will likely never pick up a company financial report during their analysis. But in the same way, top-down investors don’t know their companies, and there is more uncertainty when a bear market hits.

Bottom-up investors select their investments for specific reasons–such as their ability to innovate when times get tough. And for this reason, they are not always subject to the same dangers present in top-down investing. 

Not to mention that bottom-up investments are typically made closer to home as they are a product the investor believes in strongly and likely uses on a daily basis. Either way, however, both bottom-up and top-down investment strategies are both for the long term. Take a look at the table below:

Bottom-Up InvestingTop-Down Investing
Is Long-TermXX
Requires ResearchXX
Requires High-Level Financial KnowledgeX
Is DiverseX
Can be Susceptible to Foreign PolicyX
Can Better Weather a Bear MarketX
Carries RiskXX

Should You Consider Top-Down Investing? 🤔

Still unsure if you should try top-down investing? Well, the decision is ultimately yours, but it may help to ask the following questions:

  • ☑ Are you new to investing?
  • ☑ Are you curious about international investments?
  • ☑ Is reading a GDP a simple task?
  • ☑ Does reading the financial reports of a company sound scary?
  • ☑ Are you looking for a diverse, long-term investment?

If you answered ‘yes’ to all of the above questions, then top-down investing may be a good fit. This is because top-down investing is great for those who are new to investing, but curious about international economic performance and stocks. It is also a diverse and long-term investment.

Did you answer no to some of the above questions? Then it may be better to look at a different type of investing, as top-down investing may not suit your investment style. 

Conclusion 🏁

Overall, top-down investing is a great way to start out an investing career without having to look at company financials, learning how to read a P/E ratio, or performing advanced stock analysis. Instead, an investor can get started with just a few google searches and use knowledge gained from simply watching the news. 

Just because top-down investing is great for newcomers, it isn’t without risk, and investors in this strategy will still be subject to lots of variables that normal investors don’t deal with regularly. But as long as an investor is aware of the disadvantages of top-down trading, it is definitely worth considering as an investment strategy for a portfolio. 

Top-Down Investing: FAQs

  • What is the Meaning of the Top-Down Approach?

    The meaning of the top-down approach is investors start looking at an investment from a macroeconomic perspective, such as selecting a country based on GDP and then narrowing down the asset selection from there. 

  • What Are the 5 Steps of Top-Down Investing?

    The five steps of top-down investing are looking at macroeconomic trends, choosing a country, looking at sectors, choosing an asset, then possibly choosing an individual company (if it gets that far).

  • Is Bottom-Up Investing a Better Approach than Top-Down?

    Whether or not bottom-up or top-down investing is better will depend on the type of research an investor wants to do to invest. If you want to look at financial reports, bottom-up is better, if you like macroeconomics, then it’s better to pick the top-down approach. 

  • What Are the 4 Investment Strategies?

    There are many more than 4 investment strategies, but 4 of the most popular are: Value investing, Growth Investing, Momentum Investing, and Dollar-Cost Averaging investing. 

  • What Limitations Come with Top-Down Investing?

    With top-down investing, an investor rarely takes a look at an individual company he may place an investment in. The investor is then limited on the information they know about their company in regards to surviving a recession, bear market, or other unforeseen circumstances. 

  • Can Day Traders Use the Top-Down Approach?

    While day traders can use the top-down approach to investing, this is typically a long-term investing approach and many day traders will find that it is not worth it for them to do the research necessary for a top-down investment for a simple day trade. 

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