Investment Strategy and Superior Returns

"Style investing," where money managers rotate between small and large, and value and growth stocks, is all rage on Wall Street.

Historical data seem to imply that:

• small stocks outperform large stocks and
• value stocks outperform growth stocks

Yet the historical returns on these investment styles may not represent their future returns at all.

• The superior performance of small stocks over large stocks depends crucially on whether the 1975-1983 period is included.
• Furthermore, the superior performance of value stocks over growth stocks may not be inherent to the industry they are in but merely reflect fluctuations in investor enthusiasm about certain sectors.

All these implies that the average investor will do best by diversifying into all stock sectors.

• Trying to catch styles as they move in and out of favor not only is difficult but also is quite risky and costly.
• Hot sectors or investment styles can lull investors into a trap.
• When a sector reaches an extreme valuation level, such as the technology issues did at the end of the technology bull market, reducing its allocation will improve your returns.

An investor can use the lessons of history to avoid getting caught in the next technology, stock or market bubble.

Also read:

Bubbles: Does history guide us?
Bubble lessons never go out of style