Value Investing or Index Investing? Which one should you choose? (2018 Update)
KEYWORD PHRASES: Value vs. index funds
You may have come across countless investment success mantras in due course of investing. But, in the long run what matters is your analysis of every investment strategy you want to implement. Value investing and index investing are undoubtedly the two most common types of investment strategies for investors. And both of them have their fair share of supporters as well. Investment geniuses like Warren Buffet have successfully earned great returns using both the investment approaches. However, prominent investors like Benjamin Graham and Charlie Munger are the biggest advocates of value investing.
Value Investing v.s Index Investing
Value investing requires investors to have a micro approach to the stock market whereas index investing demands people to look at the market as a whole. For pre-investors or amateur investors picking the right investment strategy can be challenging as there are too many opinions propagandized by famous investment thought leaders. The more you expose yourself to the value vs. index funds debate, the more confusing things get. So, here we will first try to understand both these investment approaches objectively and then look at their pros and cons. With this information in hand, you will then be able to make better choices for your investment profile.
To understand index funds, let’s begin by defining an ‘index’. An index in the investing world is a representation of a part of a market. It is more of a benchmark that people use to assess the market trends. It would be very difficult to track every single security that trades in the Singapore Exchange, a smaller sample of the market is taken as a representation of the whole. The Standard & Poor’s 500 is an index representing 500 of the biggest US companies.
Index funds are a type of mutual funds. So they are usually a collection of investments comprising of stocks, bonds, real estate and so on. Index funds are termed as ‘passive’ by a lot of investors as they are typically a copy of an index. While investing in index funds your fund manager will not use his skills to pick the stocks in the market but will blindly follow the index. An example of this type of fund is the ABF Singapore Bond Index fund.
For those of you who have read multiple reports on the value vs. index funds debate, you may know that Value stock investing involves the purchase of stocks which are priced lower than their intrinsic value. Value investors actively look for stocks they believe the market has undervalued. The crux of this investment strategy is that value investors choose not to follow the conventional market sentiment. These investors believe that the market reacts to the good and bad news of companies that affect the stock price of those companies. These temporary alterations in the stock prices are generally not in sync with the long-term goals of the company. This gives these investors the opportunity to earn profits when the share prices deflate.
Even among value investors, there are certain common patterns found. These patterns result in the different types of value investors. The buy-low, sell-high investor, analyses the stocks and then picks undervalued stocks with the hope of selling them when their prices soar. The passive-income value investor, aims at banking on passive income. They look for undervalued companies that pay out regular dividends to its shareholders. The long-term value investor focuses on picking the right stocks and the right time to invest in them. They do a fair amount of research and analysis to choose the right companies to invest in. If they find a good company they not only hold on to their investment but also increase their stakes in the company.
Value vs. index funds, which one is right for you?
To arrive at the right type of investment approach, you need to first define your financial objectives. And in order to do that, you need to ask yourself these three questions
- What is the amount of money that you want to invest?
- For what duration do you want to invest your money?
- To what extent can you monitor your investments?
If you want to devote a lot of time to your investments, then maybe value investing is the thing for you. But, if you are looking at a passive investing style, then you should certainly opt for index investing. As you progress in your investment strategies, you will be able to figure out what type of investment approach suits you the best. There are a few exceptions who manage to do well with both of types of investment. Warren Buffet is one among them. Hence, it won’t be wrong to rely on his advice. In an interview to CNBC, he pointed out how index investing can help build a good retirement savings plan. He says, “The trick is not buy the right company but to buy stocks from the S&P low-cost index fund and to stick to this through thick and thin especially through thin”. When it comes to value investing he follows the Benjamin Graham school of investing. He aims for ownership in quality companies that are extremely capable of generating earnings. To do this he analyses the company’s potential to make money as a business.
So, the value vs. index funds debate is probably only a hurdle for the early investor. As you advance in your investment journey you will be able to figure out which approach works well for you.
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