In Part 1 we examined how resistance to social pressure is one hallmark of value investors.
In Part 2 we look at a second characteristic: A Constrained Approach to Risk/Reward:
Constrained Approach to Risk/Reward
It's not that value investors don't enjoy big wins; they're just not driven by them. They are content to invest in a narrower financial (and emotional) range.
To borrow from baseball parlance, in an age where investors are going for home runs (or striking out), value investors are "contact hitters". They're not looking to hit home runs. Their goal is a line drive in the gap.
The initial appeal of the value investment is that it is cheap. Value investors instinctively seek bargains. Moreover, stocks that are closer to the floor (relatively speaking) have less far to fall. The perceived safety is a big attraction to value investors
But value stocks don't just limit their downside, they limit their upside as well. By definition, value investor like a stock price below intrinsic value. When the price catches up and begins to exceed the intrinsic value of the stock, it eliminates the reason for owning the stock. In other words, value investments have a kill-switch.
This reflects a markedly difference psychological make up on the part of the value investor from their growthier counterparts. Growth investors want people on the bandwagon. They love momentum. The more the merrier!
Value investors want people to get on the bandwagon too... for a while. But as more and more people pile on, the value investors begin to feel a bit crowded, even unsafe. So value investors declare they have had a good time, call it an evening, and disembark the now unbearably congested bandwagon. Then they watch the party roll on down the road, into what they suspect, will be a ditch.
The constrained approach to risk/reward is characterized by certain personality traits, such as excitement-seeking and loss aversion. These (and other) personality traits are discoverable and quantifiable via MPI's Investor Personality Assessment Tool.
We invite you to write us for questions HERE on how you can use this tool for your clients or to schedule a free demo.
Part 3 in Portrait of a Value Investor coming soon.
In the meantime, hey, let's be careful out there.
Frank Murtha, Ph.D.
Co-founder, Evangelist of MarketPsych Insights.