What is 'Factor Investing'
Factor investing is an investment strategy in which securities are chosen based on attributes that are associated with higher returns. Factor investing requires investors to take into account an increased level of granularity when choosing securities; specifically, more granular than asset class. Common factors reviewed in factor investing include style, size, and risk.
BREAKING DOWN 'Factor Investing'
Portfolio diversification has long been a popular safety tactic, but the gains of diversification can be lost if the securities chosen react the same way to market conditions. For example, an investor may choose a mixture of stocks and bonds that all decline in value when certain market conditions arise. Factor investing is designed to look at specific attributes and determine whether securities will move in the same direction, and adjust portfolio holdings to reduce this risk.
Traditional methods of portfolio diversification, such as 80% stocks and 20% bonds, are relatively easy to implement. This makes factor investing seem overwhelming because there are a large number of factors that an investor can focus on. Rather than focus on complex attributes, such as momentum, investors new to factor investing can focus on simpler attributes, such style (growth vs. value), size (large cap vs. small cap), and risk (beta). These attributes are readily available for most securities, and are listed on popular stock research websites.