Why do value stocks edge out growth stocks? It’s a question of price, asserts Steve Pomeranz, a Certified Financial Planner since 1981 and a syndicated NPR radio commentator.
First, a question: How many of you who have invested in the stock market would like to know when the next major market downturn will be so you can protect yourself beforehand? If I was posing this question to a large audience, I would see a sea of hands. I mean, who wouldn’t like to know the answer? Everyone wants to ride the rocket up and would love to not be strapped-in for the inevitable fall.
So here’s the problem: much of the financial media as well as the venerable Warren Buffett continually tout the benefits of investing in low cost S&P 500 Index funds. You know the S&P 500 (Standard and Poor’s 500): it’s a list of stock prices of 500 of the most important companies in America.
It’s made up of the companies like Apple, Exxon, the Walmart and the Proctor and Gamble of the world, just to name a few. S&P 500 index funds are a great way to own a piece of all the companies in the index, to capture and reinvest dividends, and to enjoy lower taxes than actively managed funds thanks to minimal buying and selling within the fund.
I actually agree with the idea that an S&P index is truly a wonderful way for an investor to create wealth over a long period of time. That said, it has certain problems that tend to make it a very mediocre investment for most people.
And you’ll never guess why most people do so miserably with this investment. This has nothing to do with historic performance, fees or other technicalities. It's because...wait for it…boring!
Choosing to invest in an S&P 500 is a one decision “decision” that is supposed to last you for the rest of your life.
Most of us could not stand idly by without doing something for the rest of our lives. Markets go in cycles. They go up, they go down. Sometimes they go down mildly, and sometimes they go down horrendously. Unfortunately, the average investor can’t stomach the pain and a huge number of them will act to reduce it, namely by selling their shares.
So here is my first myth that is keeping you broke.
Myth #1: S&P index funds guarantee investing success
“I should invest in the S&P 500 and it should be the only stock investment I should make!”
The reality? It could be your worst.
So you may ask how I know this. Well, I have proof. Numerous studies have shown that, while the S&P 500 had earned over 8% annually during the period of 1996-2015, the average investor earned only slightly over 2%. That is $320,000 of lost earnings on a $100,000 investment over 20 years.
What accounts for this disturbing differential? I think it’s the emotional impact of suffering through market volatility. It is a result of the compelling force to have to do something during periods of distress. Like I said at the beginning: we would all love to avoid market downturns.
So what can we do about it?
Create a diversified portfolio of investments that Yin while others Yang. In other words, add some bonds. Add some real estate, add some foreign markets to the mix.
Make the S&P 500 the core part of your stock portfolio and “explore” with the rest of your investment funds, adding these other types of investments
Read a book on investing psychology. There are many good books and they will help you dramatically.
Myth #2: Growth stocks outperform value stocks
Growth stocks like Apple and Google make you more money than boring stocks like Walmart, General Electric and AT&T.
Hey, who doesn’t love a great growth story? Apple going from $3 per share to $153, Amazon rising from $10 to a staggering $800 per share and so on. They’re fun and sexy and make great copy for articles and front covers for magazines.
These disrupt old industries and many improve the economy and improve our lives, and they make twenty-somethings into billionaires. (Although I hate to say it, but a 26-year-old Snapchat billionaire tees me off!)
But there are more facets to the growth vs. value stocks debate. Once again, evidence shows that the boring path wins over time.
In 2013, Ibbotson’s yearbook showed that value stocks (read: boring) had a clear advantage over growth stocks.
From 1928 to 2012, large cap growth stocks grew at an average rate of 8.8% while value stocks earned 11.0%.
That’s additional growth of 22% in your investment account.
Why do value stocks edge out growth stocks? It’s a question of price. Growth stocks do, indeed, grow at faster rates than value stocks for a period of time, but growth stocks already price in rosy future growth. If that growth slows down, these companies can come crashing back down to earth. They often collapse quickly like hot air being let out of a balloon.
Of course, value stocks fluctuate too, but generally not to the extent of growth stocks. So bottom line? Don’t place all your faith in the standard growth vs. value stock story that reveres investors who got an early call correct. (How many calls did they get wrong that you didn’t hear about?). Don’t become infatuated with the sexy go-go stocks of the day. Own some of them, yes, whether through an index fund or directly, but don’t ignore their boring cousins. It’s the ones who don’t make the most noise that could make you the most money.
