- 1Index funds give you market returns at the lowest possible cost
- 2Factor investing aims to beat the market by systematically tilting toward proven characteristics
- 3Both are superior to most active stock picking
- 4Factor investing adds complexity and tracking error in exchange for potentially higher returns
- 5The best approach depends on your goals, time horizon, and tolerance for underperformance
#What Are Index Funds?
Index funds track a market-cap-weighted benchmark (like the S&P 500) with minimal deviation. They give you:
- Market returns — you earn whatever the market earns
- Minimal fees — expense ratios as low as 0.03%
- No decisions — just buy and hold
- Tax efficiency — low turnover
The Case for Index Funds
Jack Bogle's insight: since the market is a zero-sum game (before costs), and costs are certain while skill is uncertain, the average investor is best off matching the market at the lowest cost.
After fees, the majority of active managers underperform index funds over any 10+ year period.
#What Is Factor Investing?
Factor investing goes beyond market-cap weighting to overweight stocks with specific characteristics that have historically predicted outperformance:
| Approach | What You Own | Expected Outcome |
|---|---|---|
| Index Fund | Stocks weighted by market cap | Market return |
| Factor Investing | Stocks weighted by factor scores | Market return + factor premium |
The Case for Factor Investing
Academic research across 50+ years shows that certain characteristics—profitability, momentum, value, low volatility—earn premiums over the market. Factor investing systematically harvests these premiums.
#Head-to-Head Comparison
| Dimension | Index Funds | Factor Investing |
|---|---|---|
| Expected return | Market return | Market + 2-5% premium |
| Cost | Very low (0.03-0.10%) | Low to moderate (0.15-0.50%) |
| Turnover | Very low | Moderate (monthly/quarterly) |
| Tracking error | Zero | Moderate (3-6% vs. market) |
| Complexity | None | Moderate |
| Worst-case scenario | Market downturn | Market downturn + factor underperformance |
| Academic support | Strong | Strong |
| Required patience | Standard | Higher (factors can lag for years) |
#When Factors Underperform
Factor investing doesn't beat the market every year. Every factor has periods of underperformance:
| Factor | Worst Period | Underperformance |
|---|---|---|
| Value | 2017-2020 | -25% vs. market |
| Momentum | Q1 2009 | -55% in 3 months |
| Quality | 2020 meme stock era | Lagged speculative stocks |
| Low Vol | 2020 recovery rally | Missed risk-on bounce |
During these periods, factor investors face severe behavioral pressure to abandon their strategy — which is exactly the wrong thing to do.
#The "Smart Beta" Middle Ground
Many ETFs now offer factor exposure in an index-like package:
| Type | Example | What It Does | Cost |
|---|---|---|---|
| Market Cap Index | VOO (S&P 500) | Tracks the market | 0.03% |
| Single-Factor ETF | QUAL (Quality) | Tilts toward quality | 0.15% |
| Multi-Factor ETF | GSLC (Goldman) | Combines multiple factors | 0.09% |
| Equal Weight | RSP | Equal-weights S&P 500 | 0.20% |
These products give you factor exposure with the convenience of an ETF. However, they typically apply factors less aggressively than a purpose-built quantitative model.
#Who Should Use Each Approach?
Index Funds Are Best For: - Investors who want simplicity above all - Those with short time horizons (under 5 years) - Anyone who can't tolerate periods of underperformance - Small accounts where the extra return doesn't justify complexity
Factor Investing Is Best For: - Long-term investors (10+ year horizon) - Those who understand and accept tracking error - Investors comfortable with systematic, rules-based approaches - Those willing to stay disciplined during factor drawdowns
The Practical Combination
Many sophisticated investors use both: - Core allocation (60-80%): Low-cost index funds - Factor tilt (20-40%): Overweight stocks with strong factor scores
This captures most of the factor premium while limiting tracking error and maintaining simplicity.
#Our Role in the Factor Investing Ecosystem
Our rankings help investors identify stocks with strong factor profiles. You can use our research to:
- 1Screen for factor-tilted stocks to add to an index fund core
- 2Evaluate individual stocks you're considering
- 3Build a factor-tilted portfolio across sectors
- 4Understand why a stock is performing (which factors are driving it)
We provide the analysis and factor scores — the portfolio construction decisions are yours.
Explore factor-ranked stocks →
#The Bottom Line
Both index funds and factor investing are far superior to most active stock picking. Index funds are simpler and cheaper. Factor investing offers higher expected returns with higher complexity and tracking error.
The choice isn't either/or — many investors benefit from combining both approaches.
Last updated: February 1, 2026