Andrew Hallam
20.01.2020

Why Your Fast & Furious Stocks Might Be Putting You At Risk
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Imagine two racing cars. One is called Growth. The other is called Value. They have been racing each other around the same giant track for more than 100 years. Sometimes, Growth records faster lap times. Other days, Value circles the track far faster than Growth. But Value is usually the faster car. That’s why it adds to its lead roughly 8 out of every 10 decades. As a result, it’s thousands of miles ahead.

But when Growth runs well, people often bet in droves. They say, “This time it’s different. Growth will now always win.” But when almost everyone believes in a turning of the guard, Value kicks into gear to increase its long-term lead.

I’m really talking about growth and value stocks. A growth stock is one that’s rapidly increasing its business profits. It’s a stock like Facebook, Alphabet (Google) and Tesla. Unfortunately, when growth stocks are popular, their stock prices rise far faster than their business earnings. Eventually, that always spells trouble. It’s like a racing car’s pit crew forcing more air into the tires after every fast lap. That’s what’s happening with growth stocks now.

Their business profits are growing. But their stock prices are rising far faster than business profits. At some point, those prices are going to burst.

In contrast, value stocks are boring. Sometimes, their stock prices rise slower than their business earnings. The longer this happens, the bigger the reward for patient value stock investors. Today, growth stocks are in vogue. They have beaten value stocks for more than 10 years. But value always roars back. Below, I’ve listed the decades when value beat growth and when growth beat value.

When examining the past 83 rolling 10-year periods, value beat growth about 82 percent of the time.

Growth Versus Value: Which Won and When?

*To October 31, 2019
Source: Dimensional Fund Advisors, portfoliovisualizer.com

Growth stocks are racing. But that doesn’t mean value stocks are running on flat tires. According to Vanguard, U.S. value stocks gained 11.07 percent over the past 12 months, ending November 30, 2019. They also averaged compound annual returns of 11.69 percent, 9.57 percent and 12.37 percent over the past 3, 5 and 10-year periods.

In other words, if somebody invested $10,000 in U.S. value stocks on November 30, 2009, it would have grown to almost $33,000 ten years later. That’s a compound annual return of 12.37 percent. It’s far higher than the long-term average return for growth and value stocks.

But U.S. growth stocks, by comparison, have raced on nitrate fuel. Over the past 1, 3, 5 and 10-year periods, they averaged compound annual returns of 21.7 percent, 18.49 percent, 12.33 percent and 14.69 percent respectively. If somebody invested $10,000 in U.S. growth stocks on November 30, 2009, it would have ballooned to about $39,300 ten years later.

Growth stocks’ price-to-earnings ratios continue to increase. That puts them in a danger-zone, much like a car with over-inflated tires. If stocks soon fall hard, overpriced stocks (as always) will lead the downward plunge.

It’s tough not to buy growth stocks (or growth stock index funds) when they’re scorching around the track. But investors should remember several important rules:

1. Maintain a diversified portfolio of low-cost index funds.

2. If the portfolio includes a growth stock index, make sure it includes a value stock index too (a total stock market index would include both).

3. Make sure the portfolio includes exposure to international stocks.

4. Include a bond market index, based on your tolerance for risk. Higher bond allocations bring lower long-term returns. But bonds add stability when stocks crash.

Too many investors, unfortunately, chase past performance. In many cases, they’re breaking sound investment rules to stockpile money in America’s fastest growing stocks. But when their racetrack turns to ice or those tires decide to burst, these are the drivers who will pay the highest price.

Andrew Hallam is a Digital Nomad. He’s the author of the bestseller, Millionaire Teacher and Millionaire Expat: How To Build Wealth Living Overseas

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Please note the value of investments can go down as well as up, and you may not get back all the money that you invest. Past performance is no guarantee of future results.