There are various types of ways in which you can invest, and one of them is factor investing. Factor investing, mainly known for its systematic and evidence-based methodology, allows you to select underlying securities based on certain attributes and factors that can drive returns.
In this blog, we’ll discuss what factor investing is, along with its types. Let’s begin!
Table OF Contents
What is Factor Investing?
Factor investing strategy refers to the strategy that involves targeting specific drivers of returns across asset classes.
These drivers (typically known as factors) are opted based upon academic research and empirical evidence, indicating the possibility that you can outperform the market in the long term.
Unlike traditional investing, where you may focus on broad market indices or individual stock picking, factor investing instead utilizes the power of these drivers (or factors) to optimize portfolio returns and mitigate risk.
How Does Factors Investing Work?
There are two main types of factor investing that are associated with the asset’s return: Macroeconomic factors and Style factors. Macroeconomic factors are the factors explaining risk across multiple asset classes, while style factors allow you to understand risk and returns with each asset class. Here is how both types of factors impact investing decisions.
Macroeconomic Factors
1. Economic Growth
A growing economy also increases a company’s profits as consumer spending increases. This directly has a positive impact on the stock market’s performance and vice versa.
2. Inflation
Inflation also has a direct relation with consumer spending, and it influences stock market performance. For instance, when the prices of goods increase, consumer spending reduces. This also impacts the investing capabilities of investors.
3. Interest Rate Changes
When interest rates increase, businesses and individuals generally deter from borrowing money or taking out loans, slowing down overall consumer spending and economic activity.
Style Factors
1. Value
Value investing includes buying underpriced securities relative to their fundamental analysis. You may track it using the price-to-earnings ratio, dividend amount, and quantity of company-free cash flows.
2. Size
As per historical data, portfolios with small-cap stocks typically exhibit greater returns than portfolios with large-cap stocks. You may understand size considering the market capitalization of stock.
3. Quality Stocks
Choosing quality stocks refers to stocks with low debt, stable earnings, and consistent asset growth. You may use common financial metrics, such as return to equity, debt to equity, and earning variability, to determine the quality of stocks.
4. Momentum
Assets that have outperformed in the past trend encompass a higher tendency to generate good returns in the future. In this strategy, you should look at the short-term returns of underlying stocks, ranging from three months to one year.
5. Volatility
The underlying securities with lower fluctuations tend to outperform in the future compared to the securities with more fluctuations. This impacts investment decisions in the long run.
Conclusion
In summary, factor investing is considered to be a research-driven approach that may help you increase returns, manage risk, and achieve financial goals. To learn more about factor investing, enroll in Upsurge.club’s stock market investing courses covering everything, from basics to advanced.
