Value vs Growth: Which is Better?


Value stocks vs Growth stocks, which is the better investment?   The debate between value investing as opposed to growth investing is an ongoing one.  Which is better depends on from which point in time you ask the question.   It’s first important to understand what the difference between the two investment categories are.


Value Investing

A value company is one that generally trades lower than its underlying fundamentals suggest that it should be trading at compared to the market or its sector.   They often have higher dividend yields, and trade at attractive (lower) price to earnings ratios (P/E).


Growth Investing   

Growth stocks are companies that have an expectation that they will grow faster than the average rate of growth for the market.  They typically demonstrate characteristics such as sales and earnings growth that is outpacing the rest of the market or their sector.  They will normally trade at an elevated price to earnings ratio, and generally pay either no dividend income, or have a nominal dividend income compared to the overall market or sector.


Different market cycles have favored value or growth at different times.  Since about 2008, coming out of the financial crisis, growth stocks have been favored over value in most years.  Investors have favored these more expensive companies.


An example of a value stock in todays market would be a company like Johnson & Johnson (JNJ), which pays more than a 2.5% dividend, but is not expected to have the same rate of growth as a company like Alphabet (GOOG); aka Google, which pays no dividend and is considered a growth stock.


Using the ten-year period ending on June 30th 2020, the ten year return for the S&P 500 Growth Index was 16.36%.  During the same period, the return for the S&P 500 Value Index was 10.69%.


However, this cycle is not perpetual.  Over the last 40 years, when the gap between the more expensive growth stocks and the more conservative value companies tends to widen, the cycle typically reverses.   After the great tech bubble implosion that began in March of 1999, the cycle reversed and from 2001-2003 value stocks outperformed.


During the 25-year period between 1990-2015, value stocks were favored.  The returns were as follows:


The S&P 500 Growth Index returned 8.72%

The S&P 500 Value Index returned 9.58%


On an annual basis, value outperformed growth 69% of the time over that same 25-year period, providing for less overall volatility.  This data was similar across large cap, mid cap and small cap indices as well.


Trying to determine when the cycle reverses is essentially a form of market timing.   However, it’s not much of a secret that the recent breakout from the bottom of the market in March of 2020 has been led by a relatively small group of growth stocks that have substantive weighting in the S&P 500.  This may mean that it is time for value companies to catch up.   Perhaps it means that the cycle will continue even longer.   One can never be certain.


If we look at recent pricing on a price to book value ratio, the difference is significant.  During the period ending June 30th 2020, the differences are as follows:


The S&P 500 traded at 3.5 times its book value.  

The S&P 500 Growth Index traded at 7.4 times its book value. 



As we can see, growth stocks have already had quite a move upward by comparison.

A look at the chart above provided by Fidelity Investments, which cites data from the University of Chicago’s Booth School of Business illustrates how over the longer term, stocks priced cheaply tend to have better long run performance.  The same chart illustrates how this has not been the recent trend over the last decade.  More specifically, since 2014 the disparity has been rather pronounced.  In this illustration, stocks are broken down by the most expensive quintile, and the least expensive quintile as measured by both price to earnings and price to book ratios.


Looking purely at return is never the sole answer either.  Investments should be looked at on a risk adjusted basis.  In simpler terms, how much more risk is needed to increase overall returns.  Generally speaking, it is fair to say that value companies tend to introduce less volatility into a portfolio than their growth counterparts.   This has been the case through most market downturns.  We saw this play out during the market correction at the end of 2018.


However, the recession and market decline induced by the coronavirus threw many of the historical norms out the window.   Society became extremely dependent on the use of remote technology as citizens were on lockdown, favoring the services offered by the technology sector, which makes up a very big part of the large cap growth space.


Time will tell as to whether or not we are about to see a reversal back into value driven companies in the short term.  We generally favor a slight bias in most portfolios toward value companies as a method to reduce volatility and enhance longer term returns over short term volatility.  This is especially important for retirees, or those closing in on retirement, as they often depend on some form of income from their portfolios.  However, the overall core holdings are a blend of both value and growth across all market caps.  Any attempt to time value vs growth on an absolute basis can result in missing a significant market move.

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What is My Rate of Return?


When questioning your rate of return, the answer seems like a simple one to a simple question.  However, like most financial matters, the answer is never as simple as it seems.   There are actually various ways in which the rate of return of an investment is measured.


One such method is what is called the Time Weighted Return (TWR).   This is a method most commonly used by mutual funds when quoting the performance of the fund.  This method measures the performance of a specific investment over a specific period of time.   This is used by investment companies because the manager of a mutual fund has no control over when investors will choose to withdraw or add money to their investment fund.   Depending on when your personal transactions occurred, you may see a different return than what is quoted by the investment company.


Another method is the Internal Rate of Return (IRR).  This method is designed to take into account the impact of cash flows either in or out of the investment fund(s).  This is a better representation of your actual experience based on when you added or subtracted funds.  This is also sometimes called a Money Weighted Return (MWR).


Which method should be used?


That depends on what you wish to measure.   If your goal was to evaluate how well you or your advisor selected a set of investment vehicles relative to other options, you would likely use the TWR method.   The reason is that short term market volatility may have a significant impact on short term results.   If two separate investors allocated dollars in the precise same percentages to the same exact investments, but one began in January of 2020, and the other in April of 2020, the results are vastly different by August of 2020.   Due to the fact that financial markets saw a steep selloff in the midst of the Coronavirus lockdowns, the outcome for the exact same strategy is wildly different in such a short duration of time.   One investor may look foolish, while the other may appear to be a genius, yet they did the exact same thing just a few months apart.  Neither is true, as the difference is little more than luck over such a short duration of time.


If you were trying to measure the performance of your 401k plan as you were saving for retirement via your bi-weekly contributions, you may have been recommended a growth-oriented asset allocation.  It’s not uncommon for someone to be told that their asset allocation has had a rate of growth of 8%-9% over the last 10 years.  However, when they look at their actual return, it may be closer to 7%.   This is a function of the IRR/MWR.


If you think about this in simple terms, the stock market is up 75% of the time.  This means that 3/4ths of the time you are paying more for the same investments every two weeks.  If done over a forty-year career, you paid quite a bit more in year forty than in year number one.  The same would be true even over a ten-year time frame.  That means your personal return over all those years of saving will most certainly be lower than the actual return of those investments over that same time frame.   This is not a reason to avoid investing, but it rather demonstrates the importance of starting early.  The younger you are when you begin to save, the less total assets you need to save to achieve the same result.


In such an example, if you wanted to see how well you did in in your 401k terms of investment selection, you’d use the TWR.  If you wanted to see your actual result in order to track your personal progress towards your retirement goals, you’d use the IRR/MWR.   The same is true in the example of an investor withdrawing funds to supplement an income stream.  The periodic cash flows withdrawn will inevitably alter their rate of return over time.


Neither of these methods is good or bad.  Instead it’s just important to understand which question is being asked, which isn’t always clear, in order to answer the question with the best possible answer.


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Asset Class Diversification: Why it Matters


The concept of asset allocation was made famous by the economist and Nobel laureate Harry Markowitz and his introduction to Modern Portfolio Theory (MPT).  The principle idea behind MPT in simple terms is the notion that an investor can maximize their returns within a given level of risk with the use of multiple asset classes.  Under this premise, an investment is not evaluated on its own, but rather how it affects the overall portfolio when added to the other investments.  One of the key variables is not just the historical performance of an investment, but how it correlates to the other investments in the portfolio.  In lay terms, does the new added investment move in the same direction at the same time as the other components.  Correlation is a mathematical measurement of how assets move.  A correlation of 1.00 are two assets that move in perfect tandem.  A correlation of 0.00 means when one asset increases, the other does nothing.   A correlation of -1.00 are to assets that move precisely the opposite.

The lower the correlation, the less frequently the two assets move in tandem.  A lower correlation is important, because as one investment does well, it offers the opportunity to do some profit taking, and add to another investment which is temporarily out of favor, also known as rebalancing.   If an investor can maintain a lower correlation, they can produce more stability in their portfolio.  This becomes extremely important when drawing an income stream from a portfolio.

One of the challenges in building a portfolio is that historical norms are not necessarily reflected in the shorter-term data.  A quick look at the longer-term comparison of various areas of the market show that small cap and mid cap stocks outperform larger cap companies.


During the period of 1926-1983 the average returns were as follow:

Small Caps returned 17.05%  with a Standard Deviation of 32.35%

Large Caps returned 11.26% with a Standard Deviation of 20.62%


Yet, from 1972-2019 the returns were less pronounced in favor of small caps:

Small Caps returned 15% with a Standard Deviation of 20.90%

Large Caps returned 13.2% with a Standard Deviation of 17.30%


The recent 10-year and 5-year returns through March 31st 2020 show the following:

Small Caps returned 8.02% over 10 years and 0.45% over 5 years.

Large Caps returned 10.44% over 10 years and 6.65% over 5 years


What can be seen in the recent data is US Large cap equities have produced higher returns with less volatility in recent years.  This is especially true for the 5-10 year data, which ends in March of 2020, a period that was much more harsh for Small cap equities as the effects of the government lockdown took effect.

Yet, what we know is that current trends are not always indicative of the future.  Other asset classes such as foreign equities have also underperformed US markets for some time.  We have also seen the correlation between US and foreign equities rise.  Over the last 10 years, the S&P 500 has maintained a high correlation with the MSCI EAFE index of about 0.85.  While it’s reasonable to expect that with a much more global economy that is quite interconnected as compared to even 50 years ago, correlations will remain high.   That does not necessarily mean that US market will consistently continue to outperform.  They may or may not continue that trend.

We see from other asset classes like Real Estate Investment Trusts (REIT’s) that the correlations to the S&P 500 remain moderate.     During the recent period of 1999-2019 the correlation between the S&P 500 index and REITs was about 0.65, while REITs returned 9.90% per year, making it an excellent diversifier.

One of the best diversifiers of risk remains investment grade bonds.  During the last ten years, which has seen record low interest rates, the Barclays Aggregate Bond Index has returned 3.77% for the period ending March 31st 2020.   However, the correlation between the investment grade bond market and the S&P 500 index has been a negative correlation of -0.22.

With each corresponding asset class, there is a trade-off of risk versus return.  However, the data stills suggests that a diversified approach of incorporating all of these assets into one integrated portfolio will produce the least amount of volatility.    Just as it is not prudent to attempt to guess when to get in or out of markets, it is also not wise to assume that you will know which are of the market will lead over the next decade.  It may be time for Emerging Market equities to lead, or perhaps Developed International markets.  If all of the recent new money creation leads to inflation, then Commodities would likely be a leader.   Many believe that Small Cap equities are primed to lead over the next several years.  Then there is always the endless debate of Value versus Growth companies.  Asset classes are very much cyclical.   Sometimes the cycle will last a few years.  Sometimes for a decade or more.  Since there is no plausible way to be certain, the principles of Modern Portfolio Theory still apply to any sound financial plan.



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Sequence of Returns: A Substantial Risk to Retirees


There are certain constants in life that we all assume as part of our day to day lives.  Among them are death and taxes.  We also presume that it will always be the case that 7 – 6 = 1.  While this is true in math class, it is not always the case in financial planning.   How can this be you might wonder?

The reason this is the case in financial planning is that investment returns are no lineal.   Investors too commonly make the mistake of assuming that if they have an average return of 7% annually, that they can simply spend 6% of their assets, and they will continue to grow their principal by a factor of 1% per year.  This may or may not be true depending on the timing of their investment returns.    An average return is a set of randomized results that arrive at a longer-term average.   If you arrive at an average return of 6%, it is often the case that you may not have had a single year in which you actually earned precisely 6% on your investments.   As part of this long-term average, you will have negative and positive years mixed together.  While markets are remarkably consistent over the longer term, they are highly unpredictable in the short term.

What happens if you happen to realize a significant number of those negative years early on as opposed to several years from now?  While this is irrelevant if you are savings money for retirement for the next 25 years, it is extremely impactful if you are among the large number of retirees who use their investment portfolio as a source of income.   Why does this matter?  If you have an average return while saving money for 25 years, the result is identical regardless of when the returns occur.   However, the moment you introduce withdrawals into the equation, the math changes dramatically. 

Below is an example from a white paper done by Fidelity Investments several years ago.   In this case:

Investor A and Investor B both begin with $100,000.

Investor A and Investor B both average a 6% annual return for 25 years.

Investor A and Investor B both withdraw $5,000 a year from their portfolio.

What you can see from the end result is that by year 20, investor A is completely out of money, while investor B has more than doubled their asset value by year 25.   The difference is the sequence of returns.  In this example, the annualized returns are simply reversed.   Year 1 for investor A became year 25 for investor B, and vice versa.   Simply reversing the order in which the returns took place produced a dramatically different result. 

    Portfolio A   Portfolio B 
         Year       Return      Balance      Return       Balance
            0         $100,000         $100,000
            1           -15%        $80,750            22%        $115,900
            2             -4%        $72,720              8%        $119,772
            3           -10%        $60,948            30%        $149,204
            4              8%        $60,424              7%        $154,298
            5            12%        $62,075            18%        $176,171
            6            10%        $62,782              9%        $186,577
            7             -7%        $53,737            28%        $232,418
            8              4%        $50,687            14%        $259,257
            9           -12%        $40,204             -9%        $231,374
           10            13%        $39,781            16%        $262,594
           11              7%        $37,216             -6%        $242,138
           12           -10%        $28,994            17%        $277,452
           13             19%        $28,553            19%        $324,217
           14             17%        $27,557           -10%        $287,296
           15              -6%        $21,204               7%        $302,056
           16             16%        $18,796             13%        $335,674
           17              -9%        $12,555            -12%        $290,993
           18             14%        $8,612               4%        $297,433
           19             28%        $4,624              -7%        $271,962
           20               9%        $0             10%        $293,658
           21             18%        $0             12%        $323,297
           22               7%        $0               8%        $343,761
           23             30%        $0            -10%        $304,885
           24               8%        $0              -4%        $287,890
           25             22%        $0            -15%        $240,456
Average Return              6%             6% 

Withdrawal Rates

The next question is how do you defend against such a risk?  The answer is rooted on two key variables, which are withdrawal rate, and asset allocation.   It is not possible to time markets with any degree of consistency.  As a result, neither you or your financial advisor have any real ability to control when such returns occur.  The stock market is positive approximately 75% of the time, while the bond market is positive approximately 94% of the time.   This data is remarkably consistent over the longer term as referenced earlier.  However, because the short term is so unpredictable, no matter how well you design a portfolio, the sequence in which your average returns occur is little more than luck. 

Numerous financial planning studies on withdrawal rates have demonstrated that if you plan to spend down assets from your investment portfolio as a source of income, then it important to limit that withdrawal rate to 4% annually.   This assumes that you will increase spending over the course of your retirement with inflation, so the annual income is not level.  Using such a 4% withdrawal rate, it is highly probable that you should be able to safely spend down your asset base over the course of 30 years with a 90% confidence rate.   In fact, according to a study reported by Michael Kitces several years ago, 2/3rds of the time, at the end of 30 years you’ll have more money than you started with in year one.   However, 1/3rd of the time you’ll have less positive results, but still not likely run out of money.  In the above example, there is a 5% withdrawal rate ($5,000 per year from an initial balance of $100,000) being attempted.  Yet, even with a 6% average return, the results for Investor A failed within 20 years.  A 5% withdrawal rate is generally considered to be high for someone in the early stages of retirement, and not recommended.

Asset Allocation  

All of the above data on withdrawal rates of 4% is premised on the notion that you maintain a consistent asset allocation that has a risk profile in the vicinity of 50% stock and 50% bonds to 60% stocks and 40% bonds.   This presumes that you do this in a highly diversified way, rather than concentrate in a small group of stocks and bonds.  This also presumes that you do not attempt to time markets, but rather maintain this risk profile through up and down markets.   Introducing too much or too little exposure to the stock market can disrupt your ability to maintain a consistent withdrawal strategy.

As referenced above, a 4% withdrawal rate is generally considered to be a safe rate of withdrawal for a 30-year duration.   If you are retiring at a traditional age 65, this should take you to age 95 years old.  As financial planners, we generally plan to age 95, as it is not uncommon to live into your 90’s anymore.   Average life expectancy is not a prudent measure to use, as this is often misleading due to skewed numbers from those people who die at very young ages due to accidents, drug abuse, suicides, etc.   These tragedies bring down the average life expectancy.  Looking at data from the actuarial society, the information suggests that a couple that reaches age 65 has a better than 75% chance that at least one of them will live into their 90’s. 

In financial planning, all of the data around an individual scenario needs to be considered.  In some cases, a retiree may wish to retiree much sooner than a traditional age, and this would likely require a lower withdrawal rate.   In other cases, a retiree may wish to withdraw a higher percentage of assets in the early years of retirement, and then plan to greatly reduce their spending in latter years.    In such cases, there are strategies that can be implemented to address both scenarios. 

Financial planning is something that must be addressed at the individual level as each individuals circumstance is unique.    

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The Greatest Risk to Investment Success: Emotional Reactions


In the midst of the recent market volatility related to the global shutdown due to corona virus, investors often become understandably emotional.  Unfortunately, emotional responses are never wise when it comes to making financial decisions.  This is especially true as it pertains to your investment portfolio.  However, we think it’s important to address some of these concerns that investors often have during such events, which are often based entirely on emotion rather than data and what is actually happening.   

“This is just gambling”

One such concern is the notion that an investment portfolio is little more than gambling in a casino.   While this may seem so to the novice investor, it is in fact precisely the opposite. 

When you enter a casino to play a game of chance, you may very well get lucky and win money in the short term. However, if you choose to stay there long enough, you will eventually lose.  The reason is simple enough.  The odds are mathematically against you.  The odds are always in the house’s favor, making a stay at a casino little more than entertainment.  

 Investing is precisely the opposite.  When you build an investment portfolio, you essentially become “The House”.   While you may have a bad couple of months, or even a year or so, the odds are always in your favor.  The longer you are invested, the better your odds become.   This presumes, that you are not trying to time markets and trade in and out of them, which is not a strategy we would never endorse, as it has no historical track record for continued success. 

What makes you “The House”?

Ultimately, people are still going to buy food, cleaning supplies, cars, houses, new computers, etc.   As a result, companies such as Clorox will continue to sell bleach, companies like Home Depot will continue to sell plywood, and companies like Apple will continue to sell phones, just to name a few.   As an investor, you represent a stake in all of these companies as part of a diversified portfolio.  And while the names of who sells what products will change over time, as long as you have a broadly diversified portfolio, you will have a stake in most all of them.    While this particular crisis has presented a sudden government induced shock to demand, it is not realistic to presume that the consumer will never buy anything ever again from you.  Yes, that means you, the owner of these various businesses you maintain stakes in as the investor. 

This is precisely why markets always recover from these types of sudden shocks, and often fairly quickly, only to set new highs.  Because ultimately, we still need to buy things, even if the government has forced us to delay them for a couple of months for the sake of protecting the health of the global population.

What if I lose everything?

This is another concern or question we have received many times over the combined 80 plus years of experience that our firm’s members have had.  While we are sympathetic to the concerns and fears investors have, this is a fear that is founded 100% in emotion, and not in reality when applying a properly diversified investment portfolio.   

If you were to invest in just a select few companies, then this can in fact happen.  Any individual company can most certainly go bankrupt.  While we can’t say for sure which companies will be bankrupted as a result of this particular crisis, we are fairly certain some business entities will unfortunately fail.

However, in a diversified portfolio, we have created exposure to virtually the entire global public market with different proportional exposure to each area.   Our portfolios are built primarily with various ETF’s and mutual funds that represent broad market indices with more than 7000 global companies, and 12,000-15,000 fixed income holdings.   As a result, in order for a portfolio to “lose everything”, you would effectively have to see virtually every public company and government on earth fail.  

If such an implausible scenario were to play out, then it really doesn’t matter what you did with your money.  The dollars you have only retain their value because they are backed by the taxing power of the United States government.  If every company were to fail, then there are no longer any businesses or employees receiving salaries left to tax, which would render your dollars worthless.   There wouldn’t be anyone producing anything for you to buy.  Nor would there be a bank to hold your money, or an FDIC left to file your claim for your lost funds. 

So, while we don’t subscribe to any such doomsday like scenarios, if you follow such fears through to a rational conclusion, it becomes clear that in such a doomsday scenario, it wouldn’t matter if you had your funds invested or not.  It wouldn’t matter if you had $1,000 or $100 million.   Money would become effectively worthless paper. 

So rather than focus on such implausible and unrealistic types of scenarios, we think its more productive to focus on history.   History tells us that these events are little more than a short-term bump in the road.  These types of declines tend to be short lived, and with the use of a proper asset allocation, it typically doesn’t take that long to return to your previous peak before you begin to see new highs. 

In order for this to be short lived, there is a process that must be followed as it pertains to asset allocation.   If your portfolio was targeted to maintain 60% stock market exposure, and 40% bond market exposure based on the financial plans you hopefully addressed in advance, then you must maintain this allocation.   That means you must be disciplined enough to take some profits in years like 2019 when equity markets outperformed substantially.   Equally important is the need to sell some of your fixed income holdings and buy into these declines as markets are declining.   All of this is designed to maintain a consistent risk profile by forcing you to sell high and buy low.  

Since markets are unpredictable in the short term, it is not realistic to pick a precise top or bottom to the market, as there are too many variables that impact this vast economic ecosystem.  Rebalancing a portfolio back to your original target risk profile is a systematic and mathematical way to consistently sell high and buy low.    They key reason this works overtime is the fact that it is mathematical, and not emotional.    However, in order to apply this approach, you must be unemotional in your application of asset allocation and rebalancing.   This is easier said then done.   As the old saying goes “the stock market is the only place that nobody wants to buy when it’s on sale”.  

Unfortunately, studies show that the average investor is not terribly good at removing emotion from the decision making process.  DALBAR, which is an independent organization that studies such investor behavior has consistently found that retail investors dramatically underperform the broad markets over the longer term.   The reasons have little to do with the investments they choose to buy, and more to do with the timing of when they choose to sell or buy, which is too often based on fear or irrational exuberance.  

As practitioners of these asset allocation principles, we are completely unemotional in our application of risk, and the need to consistently rebalance back to an original target risk profile in a client’s portfolio, regardless of market conditions.    We maintain a steady hand, because we simply know that over time, the math works.   Emotional responses can do an enormous amount of long-term damage to a financial plan that will ultimately lock in losses.  If you have an asset allocation based on a financial plan, that plan should have already accounted for the eventuality of a substantive market decline.  Such events are not a question of “if”, but rather “when” it happens.   Such events should be viewed as an opportunity, not a reason to panic.           

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