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Value Investing - You Have To Underperform To Outperform

Investing is hard. Watching as the price of your stocks go up and down can be nerve raking. As a Value Investor however, you sleep soundly at night in the knowledge that you've done your research and have confidence in you assessment of intrinsic value.

So why is the portfolio you've just started (started copying) underperforming?

One of the key characteristics of value investing is the "value effect" - the idea that value stocks tend to underperform the broader market in the short term but eventually outperform over the long term. This can be a difficult concept for some investors to grasp, as it can feel counterintuitive to intentionally invest in stocks that are not performing well.

However, the value effect is a well-documented phenomenon that has been observed in various stock markets around the world. Research has shown that value stocks tend to have higher returns than growth stocks over the long term, but may experience periods of underperformance in the short term. This is because value stocks tend to be companies that are currently out of favour with investors, leading to their stock prices being undervalued. As a result, these stocks may experience a period of underperformance as investors favour growth stocks or other types of investments. However, as the market begins to recognise the true value of these companies, their stock prices may rise and ultimately outperform the market.

The value effect has been present in the US stock market over the long term. For example, a study by Fama and French (1992) found that value stocks outperformed growth stocks in the US market by an average of 4.8% per year from 1963 to 1990. Similarly, a study by Arnott et al. (2000) found that value stocks outperformed growth stocks in the US market by an average of 5.3% per year from 1968 to 1998.

Despite the potential benefits of value investing, it is important to note that it is not a risk-free strategy. Investing always carries some degree of risk, and value stocks can still experience prolonged periods of underperformance. Additionally, the value effect may not be present in every market or in every time period, and past performance is not a guarantee of future results.

In conclusion, the value effect is a well-documented phenomenon that is an important aspect of value investing. While it can be difficult to invest in stocks that are currently underperforming, the potential for long-term outperformance can make it a worthwhile strategy for patient, disciplined investors. Ultimately, investors should carefully consider their own investment goals, risk tolerance, and time horizon before deciding whether to pursue a value investing strategy.

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