When you have a thousand companies, you also have ten thousand different opinions. It can be confusing to determine which company will perform the best. People make decisions based on various factors. Some rely on market tools, others follow popular names, and a few simply gamble by putting all their trust in luck. But all three groups should rely on one thing: a method based on data and proven financial principles. Factor based investing helps investors select stocks using measurable characteristics connected to returns.
Factor based investing is an act of picking stocks based on unique characteristics called factors. This method has been proven in the past to deliver good returns for many companies. It uses proven rules and statistics that have been tested over decades and leaves no room for unmeasurable elements like guesswork and emotions.
Think of buying a phone. You don’t buy one just because someone says it’s good. You check the camera quality, battery life, storage, processor, and price. These features help you make a smart decision. In the same way, factor investing looks at certain features of a company to see whether it is likely to perform well in the future.
Why Did Factor based Investing Exist?
Traditionally, there are two common investing methods:
- Active Investing: Experts (fund managers) actively pick stocks and try to beat the market.
- Passive Investing: Investors follow an index like Nifty 50 and simply copy the market performance.
Factor investing came as a balance of the two. It follows rules like passive investing but aims for better performance like active investing. It uses a data-based approach that combines the best of both methods.
Key Factors in Factor Based Investing
Research shows that certain characteristics help stocks perform better. Below are the key factors:
- Value Factor: If a company is undervalued or cheap, invest! It may gain value later, so you’re essentially getting a high-quality product at a low price.
- Low price compared to earnings
- High future potential
- Good business but currently priced low
- Quality Factor: Invest in companies that have:
- Strong profits
- Low debt
- Good management decisions
- Momentum Factor: If a stock has been rising recently, it may keep rising due to investor interest and positive trends.
- Size Factor: Smaller companies, especially mid and small-caps, have more room to grow. They may be riskier but can deliver faster growth.
- Low Volatility Factor: Choose stocks that do not fluctuate wildly. These are stable companies that provide smoother returns, especially in bad market conditions.
How Factor Investing Works in Practice
Many mutual funds and ETFs follow factor based investing strategies:
- Value Fund: Picks undervalued companies.
- Momentum Fund: Invests in stocks with positive performance trends.
- Multi-Factor Fund: Combines more than one factor to balance risk and reward.
Investors love multi-factor funds because one factor may not work every year. Combining factors helps the portfolio stay strong across different market conditions.
Is Factor based Investing Right for You?
Factor investing is best for:
- Long-term investors (5+ years)
- People who want better returns than normal index funds
- Investors who like data-backed decisions
- Those who want less risk than random stock picking
It may not suit people who want quick profits or enjoy taking high risks based on gut feelings.
Conclusion
Factor based investing helps you make smarter investment choices by focusing on features that historically lead to success. Instead of relying on luck or emotion, you invest based on evidence and proven characteristics.
It is like using a winning formula that has worked through different market cycles for a long time. If you have time, patience, and discipline, factor based investing can help you build a stronger, more predictable investment journey. If you need more advice and need a fund manager to manage your investments then all you have to do is get in touch with us.