Last Updated on 9 January 2021 by F.R.Costa

Invest in factors instead of asset classes. Learn how to build a factor portfolio with ease. Article originally published at Master Investor Magazine December 2018 Issue 45 p. 22-29.

Grouping of assets into asset classes isn’t good enough for diversification purposes.

Stocks have some hidden characteristics that are worth evaluating as they help identify the exact risk profile for it. In general, the investment industry has identified the following six factors as being the most important: Market, Value, Size, Momentum, and Quality.

Starting as a theoretical explanation for stock returns, factors help investors properly identify and mitigate risks when managing portfolios. Unlike asset classes, factors are mildly correlated at most, then allowing for a much more powerful diversification. While the offer of factor ETFs is vast, most of them have hundreds of holdings and a high overlap, which make them not much different from the market itself. But, with the help of a few simple accounting ratios, an individual investor may quickly build his own factor portfolio.

About F.R.Costa

Filipe has more than 20 years experience with financial markets. He holds a degree in Economics with a specialisation in Finance and he's currently finishing a PhD in Finance. He used to work as financial consultant and research associate but then decided to return to academia five years ago. Since that, he has been an Invited Lecturer, teaching courses on Investments, Financial Markets, and Monetary Economics. He is also a regular contributor writer at The Master Investor Magazine.

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