August 18, 2013
The world of investing changed based on the research conducted by Fama and French. What did they discover? How can you benefit?
The world of investing changed based on the research conducted by Fama and French. What did they discover? How can you benefit?
Fama and French taught us that there are three main risks to think about when investing. You can consider market, size, and value. Size matters because small companies will have a 3% higher return after a long time. Value is important as well because a company that is cheap may provide a 5% higher return than other companies over a long time. To take advantage of this you must be able to wait a long time to get a return on small companies and value stocks.
Outstanding, Thomas! Let’s recap. Fama and French identified three factors when one considers investing in stocks. The market as a whole, value companies (sick companies like Kmart), and small companies. The past has provided a premium return on those value and small companies just like Thomas stated. Will the present? We don’t know, but it would probably be wise to overweight your stock portion of your portfolio to those value and small companies.
This can easily be done with a couple of ideal no-load index funds at Vanguard. The Small-cap value index fund and the Value Index fund (large not so healthy companies) are ideal choices. You can learn more on this topic by reading William Bernstein’s wonderful book, The Four Pillars of Investing as well as his shorter version, The Investor’s Manifesto.
By the way, I overweight my portfolio toward those very same index funds which are ultra cheap. You may also be able to find something similar in your 401(k) at work. Focus on the words index, small-cap, and value when doing your search.