Stock mutual funds fall under many fund types and categories but the two primary classifications or styles are growth funds and value funds. Knowing the difference between growth and value styles is important in building an investment strategy that's right for you. Combining different types of investments can also help to build a diversified portfolio.
In different words, successful investors understand what they are investing in and why they are doing it. Here's what to know when it comes to growth funds vs value funds.
- Growth stock funds hold growth stocks, which are relatively high risk and expected to grow faster in relation to the market.
- Value stock funds mainly invest in value stocks, which are selling at a low price in relation to earnings or other fundamental value measures.
- A historical study by Fidelity shows that value stocks actually outperformed growth stocks for the 26-year period between 1989 and 2015.
- For a diversified portfolio, investors may consider investing in index funds that track a broad market index, such as the S&P 500.
What Are Growth Mutual Funds and How Do They Invest?
Growth stock funds are funds that hold growth stocks, which are stocks of companies that are expected to grow at a rate faster in relation to the overall stock market. Growth stocks may be considered aggressive investments because they tend to have relatively high risk, along with relatively higher performance, compared to the broader market indices.
Technology stocks, such as Apple (AAPL) and Facebook (FB) are good examples of what growth stock mutual fund managers buy for their portfolios. But growth stock funds don't all buy the big, large-cap stocks like these. They also buy small- and mid-cap growth stocks of companies you may not have heard of but could be the next big growth company.
Growth funds pay little or no dividends so the return to the investor is realized through the price appreciation of the underlying investment; whereas the return to the investor for value/income funds can be a combination of price appreciation and yield (dividends).
What Are Value Mutual Funds and How Do They Invest?
Value stock mutual funds primarily invest in value stocks, which are stocks that an investor believes are selling at a price that is low in relation to earnings or other fundamental value measures. In simple terms, the value investor or fund manager is looking for stocks selling at a "discount;" they want to find a bargain.
Value investors or managers often employ the fundamental analysis approach to researching and analyzing corporations to determine if the stock(s) should be purchased -- to see if it's a "good value."
But instead of doing all the research and analysis, an effective means of gaining exposure to value stocks is to simply buy a mutual fund with a value objective. Most value stock funds have the word "value" in their name. Examples include Vanguard Value Index (VVIAX) and Fidelity Value (FDVLX).
Stocks and stock funds that pay dividends are often considered value funds and those that pay little or no dividends are considered growth funds. Therefore the most common purpose for using value funds is for income or yield. In different words, the investor wants or needs dividend payments as a source of income. This is why value funds are often referred to as "income funds." Retired people are the most common investors in value funds for the income feature.
Value fund investors may also choose to have dividends reinvested to buy more shares of the fund. This strategy is common for people who like value investing but do not need current income (they want to grow their investment portfolio). Therefore value stock funds can be purchased for the purpose of long-term growth, although the name or objective isn't literally "growth."
Although growth stocks have potential for outperforming value stocks, a historical study by Fidelity shows that value stocks actually outperformed growth stocks for the 26-year period between 1989 and 2015.
Growth and value are different styles of investing in stocks. The growth style tends to have a higher degree of market risk with greater potential for higher returns compared to value investing. However, growth has not consistently outperformed value in the long run. For a diversified portfolio, investors may consider a combination of growth and value, which may be accomplished by investing in an index funds that track a broad market index, such as the S&P 500.
Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.