There are several different investment strategies, or styles, that conform to different risk-reward profiles. You’ve probably heard of these styles before. Generally speaking, there are three major styles: growth, value, and income.
How investment strategies and styles differ
Not all companies are the same. Some grow faster than others. Some don’t grow at all, and instead pay out big dividends, like many REITs.
Here’s a short introduction into each style:
- Growth – Growth funds, or companies that fit a growth profile, are generally younger companies in new and emerging industries. Netflix, for example, is a perfect “growth” stock because it is in a new market (internet TV) and the market is growing quickly. Growth investors are typically focused on companies that are growing sales more so than profits. Netflix, for instance, will be investing most or all of its profits back into the business to get more market share. The idea is that the company can grow now and delay profitability until it is certain that it owns the market for internet TV.
- Value – Value funds and value stocks are generally slower-growing, mature companies in mature industries. Insurance is a classic value stock business because insurance is not a new product, nor does the insurance market grow very quickly. The car insurance business, for instance, generally grows with population growth and rising automobile prices. That is to say that it grows quite slowly. Of course, investors shouldn’t denounce this style because it lacks huge growth opportunity. Value stocks can provide high returns to shareholders because they trade less expensively, and often drive value by paying out dividends and buying back stock.
- Income – Income funds focus on a combination of growth from rising stock prices, and income from dividends. Income funds play on the idea of “getting paid to wait,” meaning that you collect dividends while waiting for a stock price to increase. Unlike growth funds which generate most of their return from rising stock prices, income investments provide balance between dividends and capital appreciation.
What’s the best style?
Over history, value has proven to be the best style. That’s over the very long haul, however. Each style runs hot and cold. During the 1990s, value-style funds were trumped by growth as a dotcom boom took hold. The Wall Street Journal writes that several years of lagging performance from value funds left investors to withdraw their funds, leading to the closure of many lagging value funds. Of course, the bubble later burst, and value funds caught back up.
Unless you have the conviction to hold through with one style even if it tests your patience for years, a mix of value, growth, and income-focused funds is a great way to go. Income funds will lead your portfolio in down years. Growth will likely lead in the most bullish of markets. And value funds will prevail as the occasional big winner, but lag for extended periods of time in between.
What if you want to be more simple? No problem – stick to an index fund.
A choice in strategy or style can be a false choice. The S&P 500 index comprised of the largest 500 stocks in industries that best align with the make up of the American economy has exposure to value, growth, and income-style stocks all in one single product. In short, it’s everything from every style in a collection that mirrors the economy as a whole. Plus, unlike style-specific mutual funds, index funds are very cheap to hold, which is why they often beat actively-managed funds over very long periods of time.
What’s the best for young adults? Simplicity. If your 401k provides for a way to pick an index fund over style mutual funds, go for the index. The cost-savings will make a bigger difference on returns than would picking a specific strategy.