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Investor Toolkit: Avoid extremes with value investing and growth investing

value stocksToday’s tip: “Early experiences may lead you to prefer either value investing—trying to buy stocks at bargain prices—or growth investing—looking for rising stocks with further growth ahead. Here’s why you should combine the two. ”

If you meet a large number of investors over a large number of years, it may seem they come in two basic categories—one inclined toward value investing, the other more interested in growth. This may be due in part to their early life experiences.

Value investing—trying to buy assets at bargain prices—has natural appeal for those who grew up in strained economic circumstances. Growth investing—trying to identify and buy rising stocks when they have further growth ahead—seems to appeal more to those who grew up in prosperous households.

Of course, having too much money early on can handicap an investor. Some investors have confided to me that they “had it too easy” in their early years. They felt this stopped them from developing that key investor attribute we often talk about, a healthy sense of skepticism. When they began investing in their middle years, they tended to be too trusting, even gullible. This can be a major obstacle to investment success. However, too much reliance on value investing can cost you money as well.

I was fortunate to have grown up under a variety of economic circumstances. My family was well-off during my first decade. Then we went through a time when I had to scramble to earn spending money at odd jobs. From age 12 through 16, I had what I thought of as The World’s Best Paper Route: all my customers lived in a set of twin 8-story apartment towers. Then, at age 16, I landed a part-time job as an assistant to an investment writer. That led directly to my career in investing.

A cheap way to learn a valuable lesson

Coming from that experience, value and growth both appealed to me. But value investing seemed safer. That’s a common misconception. In fact, value investments may only be cheap due to hidden problems. I learned that lesson when one of my earliest value investments collapsed. It was cheap in relation to its asset value, but its asset value shrank drastically after it wrote down the value of its inventory.

My loss on the stock was big enough to hurt at the time. But it was a cheap way to learn a valuable lesson. It kept me from making far more expensive mistakes later on, when I had more money to invest.

Academic studies suggest that on average, value investing produces better results than growth investing. But these studies mostly look back on what would have happened in a particular historical period, if you followed a particular set of rules. Most distinguish between growth and income investing by looking at average p/e’s (per-share price-to-per-share earnings ratios). They assume high p/e’s are a marker for growth stocks and low p/e’s for value stocks. As any serious value or growth investor can tell you, it’s more complicated than that.

If you balance and diversify your portfolio as we recommend, it should include both growth and value selections. In both areas, you should avoid extremes.

If a stock seems like an exceptional bargain in relation to earnings or asset values, it may suffer from hidden risks. The stock can plunge when those problems begin to take their toll.

On the other hand, if a growth stock trades at such a high price that it needs exceptional results to move ahead, then it suffers from obvious rather than hidden risk: a single quarter of bad earnings can spark a collapse in its value.


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