Many of us have been to a high school reunion. They’re rarely predictable. Once great wits can now sound like twits. The top football jock no longer fits in a chair. Heather Locklear’s look-alike has seen better days.
When I attended my last high school reunion, plenty had changed. The weakest-looking kid was now sculpted like a world-class mixed martial artist. A quiet, bookish girl was now a beautiful woman with a sparkling personality and career.
Such is the case with growth and value stocks. Their fortunes can flip.
Growth stocks are this decade’s Prom Kings and Queens. Vanguard’s Growth Index (VIGIX) has averaged a compounding return of 8.41 percent for the decade. By comparison, value funds are stuck in a corner. Dimensional Fund Advisors Large Cap Value Fund (DFLUX) averaged a compounding return of just 6.69 percent. Vanguard’s Value Index (VIVAX) did even worse. It averaged just 6.07 percent per year over the past ten years.
Whether we compare growth to value in U.S. large cap, medium cap, small cap, or international funds, the trend is the same. Growth has trounced value over the past ten years.
Value Stocks vs. Growth Stocks
Ten Years Ending August 31, 2015
|Value Indexes||10 Year Average||Growth Indexes||10 Year Average|
|Vanguard’s Value Index (VIVAX)||+6.07%||Vanguard’s Growth Index (VIGIX)||+8.41%|
|iShares Morningstar Large Cap Value Index (JKF)||+4.41%||iShares Morningstar Large Cap Growth Index (JKE)||+7.63%|
|iShares Russell Mid Cap Value (IWS)||+7.6%||iShares Russell Mid Cap Growth (IWP)||+8.45%|
|iShares S&P Small Cap 600 Value (IJS)||+6.96%||iShares S&P Small Cap Growth (IJT)||+8.8%|
|iShares MSCI EAFE Value (EFV)||+2.53%||iShares MSCI EAFE Growth (EFG)||+3.93%|
|Source: Morningstar.com to August 31, 2015|
Source: Morningstar.com to August 31, 2015
Just don’t be fooled by the ride de jour. Value usually beats growth. The trouble is, many investors climb onto the roof of a popular train—just to fall off when it starts to brake hard.
Research Affiliates found that growth stock funds averaged 8.38 percent between 1991 and 2013. But the average investor in growth stock funds made just 5.22 percent per year.
Between 1991 and 2013, the average value fund averaged 9.36 percent per year. But as researchers Jason C. Hsu, Brett W. Myers and Ryan J. Whitby found, the typical investor in value funds averaged just 8.05 percent. They underperformed the funds they owned by an average of 1.31 percent per year.
Research Affiliates’ Mr. Hsu and Vivek Viswanathan say that most value investors “chase trends, allocating away from value funds after a period of underperformance and towards them after a period of outperformance.” This means they buy value stocks after they have beaten growth. They buy growth stocks after they have beaten value stocks. This backward bandwaggoning gets pretty expensive.
There’s an easy way to avoid such madness. You could build a diversified portfolio of plain vanilla index funds, like Vanguard’s S&P 500 index (VFINX) or Vanguard’s Total Stock Market Index (VTSMX).
But if you’re worried that you’ll miss an A-list party, David A. Koenig, an investment strategist at Russell Investments, offers a solution. You could own a growth stock and a value stock index. To take advantage of the fact that value stocks usually beat growth, he suggests a portfolio of indexes with 60 percent value stocks, 40 percent growth stocks.
Between 1987 and 2014, this combination would have averaged 10.4 percent per year. By comparison, a value index would have averaged 10.6 percent. A growth index would have averaged 9.78 percent. The S&P 500 index earned a compounding average of 10.42 percent.
I can hear what you’re thinking. Why bother with a growth index? After all, growth stocks usually lag value and the broad market index. For an answer, look no further than the past ten years. Growth beat value. This can have a strong effect on human psychology. Owning a bit of value and a bit of growth ensures that you always have a place with the popular crowd.
Andrew Hallam is a Digital Nomad. He’s the author of the bestseller, Millionaire Teacher and The Global Expatriate's Guide to Investing: From Millionaire Teacher to Millionaire Expat.