Factor investing, from a theoretical standpoint, is designed to enhance diversification, generate above-market returns and manage risk. Portfolio diversification has long been a popular safety tactic, but the gains of diversification are lost if the chosen securities move in lockstep with the broader market. For example, an investor may choose a mixture of stocks and bonds that all decline in value when certain market conditions arise. The good news is factor investing can offset potential risks by targeting broad, persistent, and long recognized drivers of returns.
Since traditional portfolio allocations, like 60% stocks and 40% bonds, are relatively easy to implement, factor investing can seem overwhelming given the number of factors to choose from. Rather than look at complex attributes, such as momentum, beginners to factor investing can focus on simpler elements, such as 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.