Factor Basics Risks &
Did You Know You’re Already a Factor Investor?

Did You Know You’re Already a Factor Investor?

Your investments are already exposed to factors, so if your outcomes aren't what you want, it may be time to factor them in.

You’ve looked at the performance of your investments before making your choices. And you’ve taken into account their risk. You’ve done the research. But your outcomes aren’t quite what you expected and you’re not sure why. Have you factored in everything?

Whether you’re aware of them or not, factors are a part of your investments. So what is a factor? Well, it’s a characteristic of an investment that can be measured and tracked, to help explain its performance. This goes deeper than traditional categories such as sector or region. (Visit our Factors FAQ for more answers to frequently asked factor questions.)

To understand, think of your morning coffee.

Every day you drink a cup of coffee, and 30 minutes later you feel awake and alert.

But one day you drink your coffee, and 30 minutes later you still feel tired and have a headache coming on. Why didn’t you get your expected outcome? Because the barista accidentally gave you a decaf. Whether you were aware of it or not, caffeine was the factor that gave you your morning energy. Some coffees have it, and others don’t — and you can’t tell just by glancing at the cup.

While investing is more complex than sipping coffee, of course, this analogy can help you understand factors. They’re the underlying traits that can help influence an investment’s performance.

What Are These Factors And What Do They Do?

This chart highlights a few of the factors that can affect stock performance. All factors have the potential to outperform the broad market, but they have historically done so during different types of market conditions.

Remember that factors are already influencing your investments — understanding why they exist and what they can do is the first step to making them work for you. (For more about using factors in your portfolio, read "Is Your Portfolio’s Factor Exposure Aligned With Your Goals?")

Factor What it is Why it exists
Value Applies to investments trading at discounts to similar securities, based on measures like book value, earnings or cash flow. Investors tend to overreact to negative news and have a preference for stocks with rising prices.
Size Represents the potential higher-than-benchmark returns associated with relatively smaller stocks within the universe being considered. Investors tend to prefer larger stocks and may be rewarded for the reduced liquidity and transparency of relatively smaller stocks.
Momentum Identifies investments with positive momentum (recent strong returns) or negative momentum (recent weak returns) to calibrate portfolio exposure to either. Investors tend to over/under-react to market events, which may perpetuate price trends.
Low Volatility Describes investments that have demonstrated the lowest volatility compared with securities in the same asset class. Investors can treat stocks like a lottery ticket, seeking larger returns by buying relatively riskier stocks. This "lottery effect" bids up the price of riskier stocks and results in lower risk, out-of-favor stocks being systematically underpriced, which may translate into outperformance.
Quality Characterizes companies with strong measures of financial health, including a strong balance sheet. Investors tend to focus on reported earnings rather than other measures of financial health.
Dividend Yield Reflects investments defined by higher-yielding assets with higher total returns over time than lower-yielding assets. Dividend payments may provide a more defensive investment approach.
Important Information

Past performance is not indicative of future results. This does not constitute a recommendation of any investment strategy for a particular investor. This is being provided for informational purposes only, is not to be construed as an offer to buy or sell any financial instruments and should not be relied upon as the sole factor in any investment making decision. Investors should consult a financial professional before making any investment decisions if they are uncertain whether an investment is suitable for them. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing.

Factor investing is an investment strategy in which securities are chosen based on certain characteristics and attributes that may explain differences in returns. There can be no assurance that performance will be enhanced or risk will be reduced for funds that seek to provide exposure to certain factors. Exposure to such investment factors may detract from performance in some market environments, perhaps for extended periods. Factor investing may underperform cap-weighted benchmarks and increase portfolio risk.

A common assumption in finance is that increasing a portfolio’s risk exposure should generate a higher return. In contrast, the low volatility anomaly refers to the observation that historically portfolios of lower-volatility stocks produced higher risk-adjusted returns than portfolios with high-volatility stocks.

The Lottery Effect describes investor tendency to prefer stocks that may seem to offer excessive return potential.

There is no guarantee that low-volatility stocks will provide low volatility. A value style of investing is subject to the risk that the valuations never improve or that the returns will trail other styles of investing or the overall stock markets. The momentum style of investing is subject to the risk that the securities may be more volatile than the market as a whole, or that the returns on securities that have previously exhibited price momentum are less than returns on other styles of investing. Investing in securities of small capitalization companies involves greater risk than customarily associated with investing in larger, more established companies. There can be no guarantee or assurance that companies will declare dividends in the future or that if declared, they will remain at current levels or increase over time.

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