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Guide to Investing in Value Funds


Choosing the right investment strategy matters when trying to build wealth in your portfolio. Some investors favor growth, for instance, while others look for value in the markets. If the latter approach sounds like your style then investing in a value fund could make sense. Value funds invest in companies that have the potential to generate returns for investors long-term. Knowing how they work can help with choosing the right value funds for your portfolio. If you want expert guidance in selecting value funds that fit into your overall portfolio, consider matching with a financial advisor in your area.

Value Fund, Definition

A value fund is a type of mutual or exchange-traded fund (ETF) that uses a value investing strategy. Value investing, popularized by Warren Buffett, means looking for companies that the market as a whole is underestimating. The theory behind this approach is that you buy into an undervalued company and hold onto it, benefiting when the company’s stock price catches up to its actual worth.

In other words, value investing is all about finding the bargains in the market that have the potential to generate consistent returns later. A value mutual fund or ETF concentrates its holdings on these types of companies, offering investors a streamlined way to own multiple value stocks in one place.

How Value Funds Work

Value fund managers can use different techniques, such as fundamental analysis, to assess whether a company is truly undervalued. Fundamental analysis looks at various metrics, such as price-to-earnings ratio or price-to-book ratio, to assess a company’s financial health and strength.

Price-to-earnings ratio reflects the ratio between the company’s share price to its earnings-per-share. Earnings-per-share is a way to measure how profitable a company is, based on its earnings-per-share of common stock. And price-to-book ratio measures a company’s market value compared to its book value.

Value fund managers can also use comparisons of similar companies to find appropriate investments to include. Specifically, they may look at things like dividend yields between companies or return on equity. Though there’s no singular approach to choosing value stocks for inclusion in a fund, they’re generally identifiable by things like:

  • High dividend yields
  • Low price-to-earnings ratio
  • Low price-to-book ratio

Value mutual funds and ETFs can hold a large number of companies or just a few. There are value index funds that follow a specific stock market benchmark, such as the S&P 500 or the Nasdaq. These funds seek to match the performance of their respective index, rather than trying to beat the market.

Some value funds base their investment allocation on market capitalization instead. So you may have small-cap, mid-cap and large-cap value funds or funds that overlap across different market capitalizations.

Value Funds vs. Growth Funds

Couple discusses their investment portfolio with a financial advisorValue funds are essentially the opposite of growth funds, in terms of their objectives and the types of investors they’re most likely to appeal to. While value funds focus on finding bargain buys for the long-term, growth funds are more concerned with making investments in companies that have significant growth potential in the near-term. Between the two, value funds tend to be less risky since they more frequently invest in established companies.

Growth funds, on the other, offer fewer guarantees since they invest in companies that are actively engaged in growth. That could be good if the company takes off but it could backfire for you if it doesn’t.

Value funds can have lower expense ratios compared to growth funds, which is good if you’re a cost-conscious investor. And while their performance doesn’t always match that of growth funds, value funds can pay out dividends to investors who may be looking for a steady income stream.

How to Invest in Value Funds

You can buy value funds and value ETFs if your employer’s 401(k) plan if they’re offered as an investment option. Or you can invest in value funds through an individual retirement account or taxable brokerage account. Either way, buying into them is the same as any other mutual fund.

What’s more important is deciding whether value funds are a good fit for you and how much of your portfolio you want to allocate to them. If you’re looking for mutual funds or ETFs that you can buy and hold for decades to come, then value funds could be a good fit. On the other hand, if you’re looking for more of a quick win where returns are concerned then you might lean toward growth funds.

If you think value fund investing is a good fit, then it helps to get to know how fundamental analysis works as you decide which funds to invest in. Again, this just means looking more closely at a company’s financials to see how healthy it is in terms of things like:

  • How much revenue it generates
  • How profits compare to revenues
  • How much debt the company is carrying

As you evaluate value funds, remember to look at what the fund invests in and whether it uses an index strategy or not. Consider the expense ratio you might pay to own the fund and the dividends it pays out if any. You can also look at the track record of the fund manager to see what kind of returns the fund has paid out historically.

Watch Out for Value Traps

When investing in value stocks, either by purchasing them individually or through a value fund, it’s important to watch out for value traps. This means a stock that looks undervalued but really isn’t.

The danger of falling for value traps is that you could take a gamble on a stock assuming that it will grow in value over time. But because the market’s value assessment is accurate, the stock’s price never increases to the levels you’re hoping to see. Or worse, it declines which means you lose money on your investment.

Value traps can be hard to spot but generally, you should be on the lookout for red flags such as:

  • Declining earnings
  • Frequent management changes
  • High debt levels
  • Poor cash flow
  • Disorganized accounting

Talking to your financial advisor before making an investment in a company that seems like a great deal can help you avoid value traps.

The Bottom Line

Investor seeks value fundsValue funds, whether mutual or exchange-traded, can complement your portfolio if you’re focused on investing for the long-term. Many of these funds can generate consistent dividend income while exposing you to less risk than growth funds. Knowing what your risk tolerance and risk capacity are, as well as what you hope to gain by investing, can help you decide if value funds are the right move.

Tips for Investing

  • Consider talking to a financial advisor about whether value funds belong in your portfolio and if so, which ones could be the best fit. If you don’t have a financial advisor yet, finding one doesn’t have to be difficult. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • If you’re considering investing for value, you can choose between mutual funds and ETFs. Of the two, ETFs can be more tax-efficient, since they typically have less turnover of assets. And they may be more cost-efficient as well if they carry lower expense ratios.

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