Most people are familiar with broad investing ideas like index funds, growth stocks, or dividend investing. But what about factor investing? Unless you spend your weekends buried in finance textbooks, there’s a good chance you’ve never even heard of it.
This is one of those nerd alert investing concepts that most investors aren’t familiar with — at least by name. However, it’s worth knowing about because it’s quietly influenced the way Wall Street — and increasingly Main Street — invests.
What Is Factor Investing?
At its core, factor investing is a way of grouping stocks (or other assets) by certain characteristics that tend to explain their returns. Instead of buying stocks one by one, or just buying the entire market, factor investing asks:
- What traits do the best-performing stocks share?
- Are there common patterns we can capture systematically?
Think of it as looking under the hood of the stock market and noticing that certain “factors” — like company size, valuation, or momentum — often drive performance. Investors can then tilt their portfolios toward those factors.
The Most Common Factors
Academic researchers (and later, big institutional investors) have found a handful of factors that consistently matter over time. The most widely studied include:
- Value: Companies that are “cheap” relative to their earnings or assets often outperform over the long run. (Think Warren Buffett’s bread and butter.)
- Size: Smaller companies, while riskier, have historically delivered higher returns than larger ones.
- Momentum: Stocks that have been going up tend to keep going up for a while.
- Quality: Companies with strong balance sheets, steady profits, and efficient operations.
- Low Volatility: Stocks that bounce around less than the market often end up delivering steadier — and sometimes better — long-term returns.
These factors don’t always work in the short run, but the idea is that they pay off if you stick with them over decades.
How Do Investors Use Factor Investing?
Factor investing started in academia, with landmark research from professors Eugene Fama and Kenneth French in the 1990s. Their work showed that much of stock performance could be explained by exposure to just a few factors — not just the market as a whole.
Today, factor investing has made its way into the mainstream through ETFs and index funds. You can buy funds that specifically tilt toward factors like small-cap value, quality, or low volatility.
For example:
- A “Value ETF” buys more of the cheapest stocks based on earnings or book value.
- A “Momentum ETF” holds stocks that have recently been trending upward.
- A “Low Volatility ETF” screens for stocks with steadier price movements.
These aren’t exotic hedge funds — many are low-cost, publicly traded funds that ordinary investors can buy.
Why Does This Matter to You?
For most people, money expert Clark Howard would tell you: Stick with broad, low-cost index funds. That advice doesn’t change.
But understanding factor investing helps explain why some funds outperform others and why Wall Street is so fascinated by this research.
Here are a few key takeaways:
- Factor investing is a reminder that not all index funds are created equal. Some track the whole market, while others tilt toward specific factors.
- Chasing factors can backfire if you jump in and out based on short-term performance. For example, value investing can underperform for years at a time before coming back strong.
- The single most important “factor” for your success isn’t academic at all: It’s your behavior. Staying disciplined, keeping costs low, and investing consistently matter more than trying to outsmart the market.
Bottom Line
Factor investing is one of those behind-the-scenes ideas that has shaped modern finance. It’s the study of why certain types of stocks outperform over time — and how investors can systematically capture that.
You don’t need to become an expert or switch your 401(k) overnight. But knowing about factor investing gives you insight into the building blocks of market returns. And if nothing else, you’ll have a great “nerd alert” answer the next time someone at a dinner party brings up investing.
