Glancing at your account statements, you might see both growth funds or value funds as part of your overall investment portfolio.
What do these terms mean? And why do you need both?
The answer, as it is with so many investment-related questions, is diversification. You know the old expression about not putting all your eggs in one basket – that’s essentially the principle behind diversification, a way to include assets with different risk and return profiles in your portfolio. Not all assets perform the same way under the same circumstances or at the same time – that’s why you never want to be too concentrated in one asset class or investment approach.
Spot the differences: Growth vs value stocks
The differences between these two may include:
- How returns are delivered: Growth stocks are generally expected to deliver returns by way of share price. Value stocks traditionally tend to include more dividends.
- Market valuation: The market value (i.e., price) of growth stocks can be driven more by expectations of future growth. Is the company growing faster than other companies or faster than the overall economy? Is the company still in the “growth” phase of its life cycle? Growth investors are thinking about the long-term potential – and as a result, shares of growth companies are often labeled “overpriced” relative to fundamental measures like price-to-earnings ratio.
For value stocks, the market value is usually closer to the technical accounting or “book” value of the company. Value investors look for companies that appear to be undervalued by the market – that is, trading below their book value.
- Sectors and industries: Growth stocks tend to be in sectors like technology or biotech. Value stocks historically have been most commonly found in sectors like financials, real estate, energy and raw materials.
- Risk and volatility: Growth stocks tend to have a higher level of risk and volatility than value stocks, but along with that can often offer a somewhat higher expected return.
But be careful – in any specific time period, these definitions may not always play out. The old-school definitions of growth and value have been evolving in the last 20 years as the lines between technology and traditional business models continue to blur.
The importance of a diversified portfolio
Regardless of what specific definition of value or growth a specific fund manager might be using, at Edelman Financial Engines, we run an analysis of thousands of investments before designing a portfolio for you that includes elements of each that is in line with your risk profile.
That’s because as a long-term investor, you should have some balance between these two investment styles.
If you focused just on value stocks over the past decade, you would have missed out on the tremendous performance that growth stocks returned. And if you only owned growth stocks, you would have run a higher risk of deeper losses during market downturns. Holding some of each type is a smart way to avoid putting all your eggs in one basket.
Remember, working with multiple financial advisors or holding separate accounts is not the same as true diversification. In fact, that approach could expose you to more risk than you intend and may not be as effective at helping you reach your financial goals.
Investing is about planning for the future, not reacting to what the stock market does today, tomorrow or even next month. If you would like to learn how a diversified portfolio can help to drive your overall integrated wealth plan designed to help you reach your long-term goals, contact an Edelman Financial Engines advisor today.
Investing strategies, such as asset allocation, diversification or rebalancing, do not ensure or guarantee better performance and cannot eliminate the risk of investment losses. All investments have inherent risks, including loss of principal. There are no guarantees that a portfolio employing these or any other strategy will outperform a portfolio that does not engage in such strategies. Past performance does not guarantee future results.