Growth or value fund? Why not both?

One buys stocks on their way up; the other likes those on the way down

History is filled with famous feuds. The Montagues and the Capulets. The Hatfields and the McCoys. The growth managers and the value managers.

Although there have been no actual shots fired between growth and value managers — at least any that we know of — the two sides tend to look at each other askance. Put them all together in a room, and the fussin’ and fightin’ will commence.

Which side is better? By and large, both sides end up at roughly the same point over time. Your best bet is to pick both value and growth funds — or to leave the debate entirely and choose a broad-based index fund.

Let’s define terms here. Growth managers try to find stocks of companies whose earnings are likely to soar. The basic assumption: Stock prices follow earnings. A company that can grow its earnings rapidly should see its stock price rise faster than average.

Value managers, on the other hand, look for stocks of beaten-up companies and wait for them to rise to their fair value. Buying stocks below their intrinsic value gives a margin of safety in downturns, because the stocks have already been clobbered. Value stocks also tend to pay dividends, providing an additional margin of safety.

Both sides feel that they’re right. “Growth managers hold the persistent belief that longterm growth rates can be predicted,” says Robert Rodriguez, CEO of FPA Capital. “But those predictions are unreliable and fraught with over-optimism at the time of purchase.”

Fred Reynolds, manager of Reynolds Blue Chip Growth, says that many beaten-up stocks are cyclicals, such as Caterpillar or Deere, which flour- ish in a good economy and get whomped in a bad one. “If you’re wrong on a cyclical stock, you can get hurt more than you can with a growth stock,” he says.

Things are not always so cut and dried: Reynolds doesn’t believe in paying too high a price for a stock, and most value managers don’t just buy cheap stocks with no growth prospects.

You could argue that growth and value managers simply swap stocks. Growth managers buy the stocks on the way up; value managers buy on the way down. It’s the financial Great Circle of Life.

As an example, Microsoft, one of the great stocks of the late 1990s boom in growth stocks, now resides in the portfolios of many great value funds. The Yacktman Focused fund, one of the top-performing value funds, has about 6% of its assets in Microsoft.

Since the bull market began on March 9, 2009, growth funds are on top. Large-cap growth funds have gained 102% through Wednesday, and value funds are up 91%. Value funds, unfortunately, often have a weakness for bank stocks, which tend to sell for low prices, compared with earnings, and often pay decent dividends.

Is it time to jump on the growth train? It really depends on which style is in favor on Wall Street. Had you invested in one of the biggest large-company growth funds in 1979 and sold 20 years later — a long-term investment by any definition — you would have earned 3,072%, vs. 1,944% for a similar largecompany value fund.

Ten years later, the results are different, to say the least. An investment in a value fund 20 years ago would have gained 303% — welcome to our brave new world — and a growth fund would have returned 216%.

You could try a GAARP fund, which looks for growth at a reasonable price (Morningstar calls these “blend” funds). Or you could try owning a large-company growth fund and a large-company value fund, and rebalancing periodically. People who like to do that sort of thing will find it the sort of thing they like to do.

But for your basic core position in stocks, you’re best served by a broad-based index fund such as the ones in the chart. You’ll have growth stocks, value stocks and GAARP stocks. You’ll also get a smattering of midsize and small-company stocks. Furthermore, you’ll pay less in fees than you would for an actively managed fund.

Most index funds lean toward the growth side: As companies grow larger, they get a bigger position in the index.

If you want to be truly balanced, you might add a position in a value index fund, such as Vanguard Value Index (VIVAX).

In any event, you don’t need to get involved in a financial feud. Someone might get hurt. Invest in a broad index fund instead of taking sides.