For most business people, beginner traders, and intermediate traders, the hardest part of investing in stocks is stock selection. The most popular options that you may be faced with during stock selection are value stock, mutual funds and index stock funds.
In value investing, the investor identifies undervalued stocks that are trading below their intrinsic value. He then buys and holds them until their value turns around and rises. Index stock funds seek to match the performance of a major market index. If the average goes down, the fund goes down too and vice-versa.
This article will address some of the reasons why investing in value stock mutual funds is safer and better than index stock funds.
1. High Margin of Safety
When looking for the ideal stocks to invest in, a trader should assess the margin of safety in order to determine their relative risk. Volatility is widely feared in the stock market as a major investment risk, and when it hits, index fund investors can be thrown into panic.
It can quickly throw investors out of the market or lead to huge losses. However, this hardly affects value investors as they do not associate volatility with increased risk.
A value investor purchases stocks that are trading at a significant discount to their intrinsic value. This difference between the intrinsic value and the purchase price is known as the margin of safety.
Undervalued stocks have a high margin of safety; therefore, when volatility strikes, investors don’t suffer panic, losses, and market uncertainty. Rather, they get an opportunity to purchase more shares at a lower price; hence increasing the margin of safety of their stocks.
2. Low-Risk Portfolio
There are numerous strategies available in the stock market that investors can utilize and combine to create a portfolio that’s better suited for their personal goals and provide better risk-adjusted returns.
With proper research and an extensive use of Fx tools, you can find the best value stocks, growth stocks, and stocks for other strategies. You can then pick out the most promising value stocks and make a smaller, more targeted portfolio that nevertheless has a higher chance of being successful. With value investing, you don’t need hundreds of stocks to make a sizable profit.
Conversely, index funds allow investors to diversify strategies for the creation of a portfolio. However, buying them may not give you access to a lot of these good ideas and strategies. Most investors are limited to the use of just a few strategies. As a result, their ability to obtain risk-adjusted returns is minimal as compared to that of value investors.
With a smaller, low-risk portfolio of value stocks, you can focus on the indicators related to just a few stocks. Aside from minimizing the risk of losing a lot of money in a short period of time, this will also improve your efficiency as a trader.
3. Small Losses, Massive Returns
Value stocks are purchased when they are trading below their intrinsic value. The trader has the option of selling the stock at a time when it is trading at or above its actual value.
Undervalued stocks have a potential for generating exponential profits over time if they can successfully turn around.
The strategy is all about waiting out short-term market fluctuations so that you can reap long-term returns. Even if the value of your purchased stocks does not rise to expectations, your losses will be minimal as their ask price was low, to begin with. In this way, value investing is financially safer than index funds.
On the other hand, index funds don’t carry the potential to outpace the market the way value stock funds can. If you invest in an index fund, you are surrendering the possibility of massive gains.
Unlike value stock funds, where any under-performing years are canceled out by the over-performing ones, index funds’ performance remains steady over time, and this means that there are no chances of exponential gains.
4. Control over Holdings
Value investing is a safe option for investors as it allows them control over individual holdings. If you dislike a particular company due to moral or personal reasons, you can remove your money from the company without exiting the fund.
All you have to do is to contact the manager informing them that you don’t want involvement with a particular company. This form of control over holdings derives personal satisfaction for value investors.
In index investing, investors are involved with and support all the companies on their index. This means that one cannot pull out their money from an individual company unless they want to exit the entire fund. Index investing does not offer investors control over stock funds as far as the companies within their index are concerned.
5. Personal Satisfaction
Investment in value stocks requires patience as your stocks are ultimately not affected by the daily market fluctuations. Even though your stocks may underperform in a particular year, this will be canceled out by the over-performing years.
As your interest resides in long-term data and trends, short-term charts that show a high degree of variance will not bother you. By operating with a few value stocks on a larger period of time, you will only gather more of the experience needed to “read” the signs that relate to them. This will give you a higher degree of calm, which in turn will result in better-investing decisions. With value investing, the usual panic that many investors feel will be largely unknown to you.
By comparison, the numerous and greatly varied index funds can keep you awake at night as you analyze the perpetual changes that the market lives by. As a result, you may lose the satisfaction and excitement of making sound investment decisions, and this can affect your success in the market. Moreover, even if a part of your index funds is successful, failing ones may rob you of that victory entirely.
Value investing is a viable and safer option for beginners and intermediate traders in the stock market as compared to index investing. Once you have carried out adequate market research, you can invest in undervalued stocks of your choice and watch them generate spectacular profits in the long-term.
About the Author:
Ethan Featherly is a financial analyst and forecasts fan passionate about the long-term effects of short-term market trends.