This article illustrates how diversifying with growth and value funds can be an effective way to balance risk and return within your stock portfolio.
If you’re unsure about the best way to balance risk and return within your stock portfolio, you may want to consider the strategy of combining growth and value funds. Because these funds often do not move in tandem in response to market or economic conditions, you may minimize risk without sacrificing return by owning some of each.
Growth and Value Defined
Growth stocks represent companies that have demonstrated better-than-average gains in earnings and are expected to continue delivering high levels of profitability. While earnings of some companies may be depressed during an economic slowdown, growth companies generally continue to expand their earnings. The primary risk associated with a growth stock is the potential for its price to decline sharply if the company releases negative news that disappoints investors.
Value stocks, in contrast, generally have fallen out of favor in the marketplace and are priced much lower than stocks of similar companies. The lower price may reflect investor reaction to recent company problems, such as disappointing earnings or a lawsuit, which may raise doubts about a company’s long-term prospects. The value group may also include stocks of new companies that have yet to achieve recognition. Value stocks also pose a potential risk — the stock price may not rebound, leaving an investor with limited upside.
An All-Season Portfolio
Mixing growth and value funds within your portfolio allows you to potentially gain as the market moves through different cycles. Although past performance cannot guarantee future results, value stocks, often those of cyclical industries, tend to do well early in an economic recovery; growth stocks, on the other hand, tend to outperform during bull markets, which are normally fueled by falling interest rates and rising company earnings. But the good news is you don’t have to choose — combining growth and value funds may present a prudent strategy for balancing risk and return over the long term.
© 2012 McGraw-Hill Financial Communications. All rights reserved.
February 2012 — This column is provided through the Financial Planning Association, the membership organization for the financial planning community, and is brought to you by D3 Financial Counselors, a local member of FPA.