Lesson 5 of 8
What Are Factors?
The building blocks of returns, backed by decades of data
Factors are characteristics that explain why some stocks outperform others over long periods. Academics identified these patterns across 100+ years of data. They're not guaranteed, but they're the closest thing to 'edges' that persist.
Value Factor
Buy cheap stocks (low P/E, P/B)
Sell expensive stocks
Outperformed ~3%/yr historically
ETF: VTV, VLUE
Momentum Factor
Buy recent winners
Sell recent losers
Stocks that went up tend to keep going up
ETF: MTUM
Real factor ETFs and how they behave
Vanguard Value
Low P/E, high dividend yields. Wins in rising-rate environments.
iShares Momentum
Buys what's going up. Highest factor premium, but ugly crashes when it reverses.
iShares Quality
High ROE, low debt. Outperforms in recessions and drawdowns.
iShares Min-Vol
Lower volatility, smoother ride. Lags in raging bull markets.
Avantis Small-Cap Value
Small-cap value is historically the strongest factor combo. Ride the roller coaster.
Historical factor premia: momentum ~4%/yr, value ~3%/yr, size ~2%/yr. These are long-run averages with decade-long droughts.
Quality Factor
High ROE, low debt, stable earnings
Companies with strong balance sheets
Outperforms especially in downturns
ETF: QUAL
Size Factor
Small-cap stocks outperform large-caps
More risk, more return over time
Less consistent than value or momentum
ETF: IWM (Russell 2000)
the catch
Every factor goes through long stretches of underperformance. Value underperformed for a decade (2010-2020). You need conviction to stick with it. Most people can't.
Check yourself
Which factor has historically produced the highest excess returns?