The multifactor approach to investing combines multiple variables, like size and volatility, with the goal of achieving more consistent performance over time. The idea is that when one factor is underperforming, the other factor may be outperforming.
There are merits to various approaches to investing, whether you’re seeking out lower volatility or larger returns. However, over time, even investments traditionally associated with good long-term performance will occasionally underperform. The idea of multifactor investing is that different factors perform well at different times, and the diversification may be able to help avoid volatility.
The multi-factor approach is based on the following tenets:
- Similar stocks tend to have similar risk/return profiles
- Filtering information mathematically instead of qualitatively allows for the identification of specific underlying factors that drive returns
- This mathematical approach eliminates human or subjective behavioral biases
Please remember that investing involves risk, including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values.