Evidence-Based Investment Insights: Factors That Figure in Your Evidence-Based Portfolio

November 12, 2026

In our last piece, “The Essence of Evidence-Based Investing,” we explored what we mean by evidence-based investing. Grounding an investment strategy in rational methodology can help investors remain focused on their financial goals, as we:

Assess existing factors’ potential to offer expected returns and diversification benefits.
Understand why such factors may exist, so we can evaluate how they might appropriately be applied.
Explore additional factors that may complement a structured investment approach.

Assessing The Historical Evidence

Decades of academic research have identified several factors that can help explain differences in investment returns.

Among the foundational equity factors described in the Fama-French Three-Factor Model are:

The equity premium: Over long periods, stocks have historically delivered higher returns than high-quality bonds, while also subjecting investors to greater risk and volatility, as we described in “The Business of Investing.”
The small-cap premium: Smaller-company stocks have historically been associated with higher average returns than larger-company stocks over certain long periods, although the premium has been inconsistent and can disappear for extended stretches.
The value premium: Stocks priced lower relative to measures such as earnings, book value, sales or cash flow have historically been associated with higher average returns than more expensive growth stocks over certain long periods. Importantly, being classified as a “value” stock does not necessarily mean a company is objectively undervalued or mispriced.

These three exposures—market, size and value—formed the foundation of the Fama-French Three-Factor Model discussed in “The Essence of Evidence-Based Investing.” Subsequent research has examined additional factors, including momentum, profitability and investment, which we will explore later in this series.

Academic research has also identified several important sources of expected return in fixed income, including:

Term premium: Investors may require additional expected return for holding longer-maturity bonds and accepting greater exposure to changes in interest rates.
Credit premium: Investors may require additional expected return for lending to issuers with greater credit risk. However, higher yields also compensate investors for the possibility of default and potential losses, so greater credit risk does not automatically translate into greater realized returns.

Understanding The Evidence

Scholars and practitioners alike strive to determine not only whether various return factors have appeared historically, but also why they may exist.

This matters because a historical pattern alone does not guarantee that a premium will continue. Researchers look for economic explanations, evidence across different markets and time periods, and results that remain robust after accounting for costs and other variables.

Explanations for persistent factor premiums generally fall into two broad categories: risk-related and behavioral.

A Tale Of Risks And Expected Rewards

One explanation for factor premiums is that investors may demand higher expected returns as compensation for bearing certain systematic risks that cannot simply be diversified away.

Value stocks provide a useful example. Some research suggests companies trading at lower valuations may be more exposed to economic stress, uncertain cash flows or other risks than their growth counterparts. If investors are reluctant to bear those risks, they may require lower prices (and therefore higher expected returns) as compensation.

That does not mean every value stock is riskier than every growth stock or that value will outperform during every period. Recent research continues to show that the value premium can vary significantly across market environments, reinforcing the importance of evaluating factors over long periods rather than judging them by short-term performance.

A Tale Of Behavioral Instincts

Risk is not the only possible explanation for factor premiums.

Investor behavior may also contribute. People can overreact or underreact to information, become overly optimistic about popular companies, extrapolate recent performance too far into the future or avoid investments associated with uncomfortable headlines.

If these behavioral tendencies influence prices, disciplined investors may be able to avoid some of the mistakes that arise from following emotional or short-term reactions.

Later in this series, we will explore behavioral finance in greater detail. For now, the important point is that differences in expected returns may arise from risk, investor behavior or some combination of the two.

Your Take-Home

Factors associated with expected market returns may reflect compensation for bearing certain risks, behavioral influences on market pricing or a combination of both.

Evidence-based investing does not assume that any factor premium is guaranteed to appear on schedule. Instead, ongoing academic research helps investors evaluate which relationships have been persistent, economically sensible and robust enough to consider as part of a diversified, long-term investment approach.

Research also continues to evaluate additional potential factors—and how established factors interact with one another. We will turn to some of those developments in the next installment of this series.

This post was written and first distributed by The Writing Company.

DISCLAIMERS

This material is intended for general public use. By providing this material, we are not undertaking to provide investment advice for any specific individual or situation, or to otherwise act in a fiduciary capacity. Please contact one of our financial professionals for guidance and information specific to your individual situation. This is not an offer to buy or sell a security.

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