4

There are many types of mutual funds. Without considering specialty funds or other particular categories (EG emerging markets, real estate, etc), what's the difference between the following 3 types? What do they really mean for an beginner investor in terms of risk, return, or other factors?

  • Value
  • Blend
  • Growth

Thank you

6

Value investing involves looking for companies that are "cheap." Cheapness can be determined by looking at statistics like price to book value, price to earnings, EBIDTA vs. Net Income, book value and many other ratios or by using valuation models such as the dividend discount model of John Burr Williams (nowadays known as Net Present Value analysis or Discounted Cash Flow analysis). The goal of value investing is to try to establish an "intrinsic" value for a company and buy companies that are selling for a large discount to their intrinsic value.

The "large" is important. If you can find a company that you think is worth $50 per share but it's selling for $25 per share, then it's selling at a 50% discount, which is big. If a $50 company is selling for $48, then that's still a discount, but not large enough. The idea is that valuation is rough so you want a large margin of safety so that even if you're not spot on, you're still guaranteed to make money.

Thus, value funds look for undervalued stocks and follow a buy and hold strategy.

Growth funds are essentially the opposite. Whereas value stocks are often out of favor and have low price to book values, growth stocks generally have high price to book and price to earnings ratios. The idea is that a growth company is growing very fast so you can justify paying a high multiple for it because it will grow a lot in the next few years and justify your investment.

Growth funds look for companies that are growing very fast and purchase those types of stocks. Growth companies are generally in favor with the market, while value companies are generally out of favor.

Blend involves a mixed strategy of some discounted value companies and some high-growth companies. These really aren't very common considering the specialization of mutual funds.

There is much debate about which strategy is truly effective in the long run, and I won't go into that here.

In terms of risk, growth funds tend to go up very fast but after they stabilize they tend to fall, and few managers can effectively pick the right growth stocks at the right time. Value funds tend to be not as volatile but they can have mediocre returns for a while (especially in bull markets) before having superior returns.

I would advise you to carefully study the purchasing history of managers of funds you're looking at. Oftentimes, "value funds" end up being "value-pretender funds" because the managers have fairly high turnover, which is uncommon in value funds. For growth funds, you want to look for managers who select companies before they become super hot and everyone jumps on. Those managers are hard to find and nobody does it consistently, but it's important to watch out for funds that simply buy what's hot and call themselves growth funds.

  • You can also just get a value/growth index fund with a low expense ratio and then the manager doesn't matter. – dg99 May 28 '14 at 18:11
  • How does this change for long term investors (10-30 years)? – Matthew Moisen Jul 26 '14 at 22:31
  • Alternatively, avoid the whole question of the manager of the funds, and go with straight index funds, where there's no manager bias. Evidence is that the lower costs of index funds make up for any improved returns active management might produce. I grant that index funds aren't exciting, but I'd rather reliably profitable than exciting. – keshlam Oct 16 '14 at 4:54

protected by Chris W. Rea Mar 28 '16 at 23:27

Thank you for your interest in this question. Because it has attracted low-quality or spam answers that had to be removed, posting an answer now requires 10 reputation on this site (the association bonus does not count).

Would you like to answer one of these unanswered questions instead?

Not the answer you're looking for? Browse other questions tagged or ask your own question.