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How Factor Investing Can Help Reduce Risk and Increase Return

August 20, 2021 by Marc Bautis
What is Factor Investing?

Discover why factor investing, a diversification strategy that minimizes risk and maximizes returns, may be a good fit for your investment needs.

Clients tend to ask me, “Can I just invest in the S&P 500?” Or, “Can I utilize a target date fund with my investment portfolio?” There are certainly worse investment strategies out there — like timing the market or chasing the hottest investment fad. US Large Cap stocks have provided great returns over the past 10 years, but that hasn’t always been the case. 

Diversification and the Lost Decade

While I am a fan of keeping things simple, there is a benefit to diversification and the 2000’s are a perfect example of this. 2000 to 2009 is the first and only 10-year period where the S&P 500 started the decade off higher than it ended it. Emerging Markets crushed it during that decade returning 162%. If you were a riverboat gambler and invested solely in emerging markets, you would have saw a great return and have an iron stomach for volatility.

But if you would have had a diversified portfolio, you would have minimized your risk and still had a 52% return over that same time period.

To further highlight the importance of diversification, the graphic below shows the year-by-year performance of various asset classes. It’s common to see the best performing asset class one year winds up near the bottom the following year.

Why Target Funds May Not Be What Your Expect 

The other simple investment strategy is selecting a target date fund that’s close to when you plan on retiring. Although this set it and forget it method is straightforward, there are things to look out for.

An article from Kiplinger, titled “The Disturbing Conflicts of Interest in Target Date Funds,” highlights potential issues, including a cumulative return loss of 21% for an average investor holding the fund for 50 years.

We also wrote about problems with target date funds, including that they assume people within a certain age should be invested the same way. That’s often not the case — based off of wants and needs, people need to be allocated more or less aggressively.

What is Factor Investing?

In addition to diversification, one of the strategies we use is factor investing. While it may seem like factor investing is a bunch of ETFs that cover the market, there is a strategy involved with the goal of minimizing risk and maximizing returns.

This visual aid uses everyday examples to show what factor investing is and how it can help.

These simple concepts are at work in your everyday life and in your investments. Targeting these factors can help you meet your investing goals, including maximizing return potential and managing risk.

From 2000 to 2020, here’s how the risk and return of the above factors compared to the benchmark MSCI World Index.

All five of the factors have had greater historical returns than the benchmark index, and some have also had lower risk.

Category: InvestmentsTag: Factor Investing, Investing Strategies, Investing Trends, Investment Tips, Investments
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