Every week I get emails from investors telling me they’re fed up with investing in value stocks.
These people are eager to see results. Their patience is wearing thin — and in many cases it’s worn out. Obviously, value stocks are poor performers, they tell me.
This issue has two important components: value stocks — and the people who invest in them.
The long-term case for value stocks is easy to make.
Value stocks are different from popular growth stocks like Microsoft MSFT, +0.08%, Google parent Alphabet GOOG, +0.43%, Apple AAPL, -1.28%, and Facebook FB, -1.00%, to name just four examples. Those stocks seem to have bright futures, and they don’t come cheap in relation to their current profits.
By contrast, you’ll find plenty of relative bargains among well-known value stocks like Walt Disney, Berkshire Hathaway BRK.A, +1.07% BRK.B, +1.10%, Johnson & Johnson JNJ, +0.12%, and Intel INTC, +1.28% — again to name just four of the largest.
Buying stocks at bargain prices has paid off very well over the long haul — especially over the VERY long haul. From 1928 through 2019, an index of large-cap U.S. value stocks had a compound annual return of 11.8%, compared with 9.9% for the S&P 500 index SPX, +0.53%.
I don’t know anybody who invested money for 92 years, but plenty of folks are investors for at least 40 years.
In the average 40-year period, an index of large-cap value stocks grew at 13.5%, compared with “only” 10.9% for the S&P 500. That’s enough extra return to make an enormous difference to long-term investors.
So why are so many people ready to bail out of value investing? In blunt terms, I think there are four main reasons.
• Not enough time.
• Not enough patience.
• Not enough good luck.
• Not enough good sense.
1. If you’re relatively advanced in age (as I am, in my mid-70s), you may not have time to reliably cash in on value investing.
As you know, investment returns don’t happen in straight, predictable lines. This means the value premium doesn’t show up on your investing statement every quarter or every year — or even every decade.
Over the past 92 years, there have been long “dry spells” when portfolios heavy in value stocks and small-cap stocks have failed to outperform the more popular stocks in the S&P 500.
During my own investing lifetime, since the late 1960s, there were three of those dry spells that lasted for eight years, 17 years, and 14 years, respectively. (Later on I’ll give you a link to a chart that shows this.) Interspersed with these were several multiyear periods when value stocks and small-cap stocks dramatically outperformed the S&P 500.
Long-term investors could benefit from those periods. But short-termers could have easily missed them.
2. One of the most reliable attributes of successful investors is patience. Yeah, I know what you’re probably thinking: You’ve heard this over and over, starting with your mother or maybe even your grandfather.
I know investors who figure out what their goals are, determine a realistic way to try to achieve them, and then sit tight for as long as it takes. I know others who pay insufficient attention when they’re setting up their portfolios, only to be startled when they DO start paying attention and learn that they haven’t reaped the big rewards they were hoping for.
Being patient isn’t as easy as it might seem. The powers-that-be on Wall Street always have a new and better solution for any investor who’s frustrated, nervous or tired of waiting for results.
And yet patience, as I have written before, is one of the hallmarks of the most successful investors. Unless you are blessed with ample good luck (see below), you’ll need patience to be a successful value investor.
3. Some investors who have sufficient time and plenty of patience still come up short — through no fault of their own — because of bad luck.
Imagine that back in the early 1980s, you had decided to hitch your wagon to the long-term track record of small-cap stocks and value stocks (in a four-fund portfolio I’ll describe below). As it turned out, you had to cool your heels for 17 years before you enjoyed five years of outperforming the S&P 500. Bad luck.
If on the other hand you had jumped on that small-cap-and-value bandwagon in the mid-70s or in 2001, your payoff would have been immediate, perhaps making you a believer for life. Good luck.
More than we like to think, investing performance is determined by this sheer luck of timing.
4. If you’re blessed with ample time, patience and good luck, you are likely to do well if you invest in index funds.
But some people seem willing to toss those three advantages out the window by engaging in active management (either by buying actively managed funds or by picking stocks themselves.) Active management can easily derail a lot of good investment choices — a topic that deserves an article by itself.
The question remains: What’s the best way to capture the long-term benefits of investing in value stocks and small-cap stocks?
My recommendation is a four-part portfolio of index funds (or exchange-traded funds) that includes the most basic U.S. equity asset classes: large-cap blend stocks (the S&P 500, in other words), large-cap value stocks, small-cap blend stocks, and small-cap value stocks.
That combination will give you the familiarity and comfort of the S&P 500 index, along with exposure to the historical performance advantages of value stocks and stocks of smaller companies.
This combination has outperformed the S&P 500 in six of the past nine decades.
I promised you a chart showing this four-fund combination vs. the S&P 500 by itself.
What you’ll see is a blue squiggly line that represents the relative difference, year by year, between the accumulative return of the four-fund combo and the S&P 500. Whenever that blue line slopes down, the four-fund combination underperformed; whenever the blue line slopes upward, it outperformed.
You’ll see five flat black lines, each representing a period from eight to 20 years. At the end of each of these periods, these two returns were essentially even with one other.
And you’ll see four bold upward-sloping green lines, each representing a period for which the four-fund combination outperformed the S&P 500.
Once you grasp the elements of this chart, I think you’ll start to see the importance of time, patience and luck in capturing the small-cap and value premiums.
For a more complete discussion of capturing the small-cap and large-cap value premium, join me for a free one-hour presentation sponsored by the American Institute of Individual Investors (AAII) at 8:30 p.m. Eastern time, Sept. 23.
The title is: “Which Is the Best 1-, 2-, 3- and 4-Fund Strategy?” You can register here.
Richard Buck contributed to this article.