Assets that are purchased to make passive or active income from that can be termed as business investments. These assets can have several risk factors involved. The most common type of investments in business or an asset class is growth funds and value funds.
Growth Funds vs Value Funds
The main difference between growth funds and value funds is that growth funds have higher market growth but offer less dividend while value funds are undervalued and have lower sales but give out a higher dividend. The main aim of growth funds is to have higher capital appreciation while value funds encourage investment in undervalued stocks.
Growth funds can be termed as a portfolio of stocks that have higher potential capital appreciation at risk of above-average. The investments usually go into acquisition, expansion, or research and development. A growth fund is typically a mutual fund or Exchange-Traded fund (ETF) where the pace of growth is higher comparatively.
While value funds are equity mutual funds of stocks that are under-performing but have the potential to perform better in the future due to various factors like business model and management, and the current competitive position. The scope of growth is high and the stocks provide a higher dividend to the investors.
Comparison Table Between Growth Funds and Value Funds
| Parameters of comparison | Growth Funds | Value Funds |
| Stock performance | Better-than average | Below-than average |
| Stock priced at | Overvalued or highly- priced | Undervalued or power priced |
| Risk | High risk | Moderate to low risk |
| Principle | Capital appreciation | Growth due to intrinsic value |
| Dividend | Lower | Higher |
What is Growth Funds?
A growth fund is a type of mutual fund with a diverse portfolio of stocks that offer capital appreciation and market growth but little or negligible dividend. An investor of growth funds needs to have a high-risk tolerance and a longer holding horizon. Growth funds can be further classified into small-, mid-, and large-cap according to market capitalization.
Growth funds function on the policy of “high risk – high reward“. Stocks with high P/E and P/S ratios fit perfectly under the growth fund domain. Stocks of medium to large companies have a steady ebb and flow and have the potential to provide higher returns while stocks of a small company can fluctuate wildly and portray aggressive growth. They do offer high returns but also need a high-risk tolerance of the investor.
While choosing any growth fund, an investor should not be tempted by any recent success or failure, but analyze the performance from a long-term period. The volatility of the stock should match the risk tolerance of the investor, to be an ideal choice. The returns of a growth fund are provided through capital gains, and not dividends because relatively low dividends by fast-growing companies and the dividends are taxed differently.
What is Value Funds?
A value fund is a type of mutual fund which have open-ended equity. Value funds work on the basic principle of investing in stocks that are undervalued but have the potential to perform better shortly. These funds are below their actual price for several reasons like inherent inefficiencies. The intrinsic value of these stocks is growth and hence offers higher dividends to their investors.
An ideal investor of Value funds should have a high-risk tolerance (because of unsure growth), a longer investment horizon (because the stocks take a certain period to show considerable growth), and have patience. Value funds may not look promising but have a higher potential for performance and growth. Value funds generate greater returns and give exposure to a diverse portfolio. The undervalued stocks are also less undervalued and hence value funds are often the common choice of angel investors like Warren Buffet.
The value funds also provide a sense of margin safety. For beginner investors, Value funds help in creating a portfolio with inexpensive stocks of great companies for a long period of investment and have higher yields. Value funds are also synonymous to value investing and it is a reliable investment opportunity.
Main Differences Between Growth Funds and Value Funds
- The Growth funds perform on the principle of capital appreciation and market growth while Value funds work on the principle of undervalued stocks grow due to intrinsic value.
- Growth funds involve high-risk tolerance and volatility of the investor while value funds involve moderate to low risk tolerance of the investor.
- Growth funds offer lower dividend yield while value funds offer higher dividend yield to the investor.
- Growth funds show growth during bull markets or economic expansion while value stocks tend to outperform during an economic recession or bull markets.
- Growth funds showcase a better-than-average performance from the market while value funds have a below-than-average performance comparatively with the other market stocks.
- Growth funds look exciting due to the recent results or performance but Value funds do not look as exciting as growth funds yet have a higher potential to grow.
Conclusion
Growth funds and value funds are types of a mutual funds. While growth funds extensively focus on overvalued stocks of large companies with high growth and offer lower capital gains, but Value funds are undervalued stocks of mid to low-level companies that have an intrinsic value to outperform.
Growth funds provide higher or steep returns over a short time while value funds provide steady returns over a longer period. The growth funds tend to lag in the bull market while most value funds outrun in the bull market. Both the funds involve high-risk tolerance of the investor and a longer period of investment or horizon. Since they are mutual funds, they have the inherent characteristics to perform or fluctuate aggressively.
While creating a portfolio, investors often choose a mixture of growth and value funds to get the best gains or returns out of the funds with minimum risk. This combination favors growth funds or value funds according to the market condition, yet generates smooth gain over a long period.
References
- https://joi.pm-research.com/content/29/6/51/tab-pdf-trialist
- https://www.nber.org/papers/w25381