Comments on: Overweighting Small-Cap and Value Stocks

By: my2fish

my2fish — Sun, 24 Jan 2010 05:27:20 +0000

I just revised my asset allocation this past week. I had been putting it off for a long time. Initially, I had started my ROTH IRA’s with Vanguard, and used the Target Retirement 2045, since the account started out at the $3k min per fund. Fast-forward a few years, account has grown, and I decided to finally get my ROTH, wife’s ROTH, my ROLLOVER IRA, and both of our 401k’s to start working together. I think the multiple accounts was what kept me from doing this earlier… I was worried I couldn’t get them to work together as one portfolio.

My favorite book on this topic is All About Asset Allocation by Rick Ferri (I’ve met him, too – cool guy), which I read years ago, but slacked off on implementing his advice. He does a good job explaining how different mixtures work together to (potentially) increase return while lowering risk… which is the intent of tilting towards small-cap value.

I decided on the following:
80/20 stock/bond mix
30% of stock % as international
25% of stock % as small value
50/50 US bonds/tips

Which breaks down to approximately the following:
35% US total stock mkt index fund (VTSMX)
20% US small cap value index fund (VISVX)
25% international index fund (VFWIX)
10% US bond index fund (VBMFX)
10% TIPS fund (VIPSX)

I’m using all Vanguard index funds (as noted above), except for a few Fidelity index funds in my 401k, and I had to approximate the total stock market using an S&P fund and an extended market fund in my wife’s 401k. But overall, I think it will work nice, and am glad I finally implemented it.

cheers, my2fish (thad)

By: Dylan

Dylan — Thu, 10 Sep 2009 19:02:31 +0000

Value and small caps are expected to lead to greater returns because of the greater risk involved, just as you suggest. But investors tent to think of this increased risk as just being greater volatility (bigger ups and downs) and say things like, “I’m willing to ride it out for those greater returns.” But, that’s not really what the risk adds up to. The risk you actually take is the risk that tilting won’t ultimately result in any greater returns and may end up hurting your returns.

Prices are set by a market. It’s the market that constantly seeks out fair value and, in doing so, prices uncertainty at a greater discount (thus creating the risk premium). And that same market does not want rewards to be disproportionately greater than risks either.

Also, when considering to tilt, there is a chicken and the egg situation that differentiates the value premium from the size premium. Any size company becomes a value company when the market makes it such by collectively concluding that its fair value should be at a greater discount to its potential future value relative to other companies. In other words, the additional risks define the composition of group.

With small cap companies, the composition of the group defines the additional risks. While capitalization is impacted by stock price, small caps are not defined by the market’s collective opinion of the each company’s risk like with value companies. Instead, the inherent risks associated with smaller capitalization companies demand a greater discount relative to larger companies companies. This difference creates a more distinct sub-market, “the small cap market,” than a “value market,” and in theory, should result in a more reliable risk premium.

By: Ben

Ben — Thu, 10 Sep 2009 18:19:48 +0000

my time frame for the 8 year return of large cap is before the market decline.

By: Ben

Ben — Thu, 10 Sep 2009 18:18:14 +0000

historicaly, at leaste when I looked at it in 2007, the value group of stocks outperformed the group over a 10 year period, a little outdated I know.

As for my domestice section I do a 60/20/20 mix, 60 large 20 mid and 20 small cap. That is because if we look at the 8 year return of the large cap it sucked from 2000-2008, which I why people are calling this the lost decade. but by adding small and mid cap all of the sudden your return for domestic stocks increased to about 4-6 % instead <1.

By: The Incidental Economist

The Incidental Economist — Thu, 10 Sep 2009 16:13:29 +0000

I don’t do it for the reasons JC raises. I don’t know how much to tilt. A little tilt won’t matter much. I’m not sure a big one makes sense. In the end, I find it easy and comfortable to cap weight. I understand it and I don’t have to think much about rebalancing.

By: JC

JC — Thu, 10 Sep 2009 16:09:48 +0000

i do it, but i put it in perspective. your overall asset allocation (equity/fixed income) to me is a much bigger decision than small-value tilting. I even think the international vs. domestic allocation you choose matters more. you basically just squeaking out an extra bit of expected return by tilting. Which brings up another issue: how much “tilting” is too much? 10% small value? 20% small value?

By: Paul Williams @ Provident Planning

Paul Williams @ Provident Planning — Thu, 10 Sep 2009 15:34:18 +0000

Mnartin (Martin?) – Historically speaking, adding small companies and value companies is better than just increasing your stock allocation for a given level of risk. Just increasing your total stock allocation does nothing to diversify yourself between the large and small companies. You’ll still have mostly large companies if you’re using a total stock market fund.

By: Retirement Savior

Retirement Savior — Thu, 10 Sep 2009 15:04:34 +0000

Another way to capture the tilt that you talk about is to tilt toward smaller caps within the large cap allocation. For instance, using RSP, which is an equal weight S&P ETF.

Small Value has been talked about a lot as the best for outperformance according the Fama/French crowd.

By: Mnartin Stern

Mnartin Stern — Thu, 10 Sep 2009 14:53:16 +0000

An alternative to adding small cap and value is to increase the proportion of the total market equity over fixed income in one’s portfolio. Increasing equity exposure also increases both the expected return and the risk. Not sure which is a better strategy for a given amount of risk

By: Mr. Bee @ Money Chronicle

Mr. Bee @ Money Chronicle — Thu, 10 Sep 2009 14:37:40 +0000

I do too. I use modified FundAdvice.com Suggested Portfolio for Vanguard, which is also featured on Paul Farrell’s Lazy Portfolios. For my domestic equities, I have equal weighting for Large Cap, Large Cap Value, Small Cap, Small Cap Value and REITs. I realized that this increased my volatility and risks. I balanced it with increasing my fixed income portion, which is very conservative since I only use Short-Term Treasury, Intermediate Term Treasury and TIPS. I listed what I have in my portfolios in this post http://moneychronicle.blogspot.com/2009/08/managing-my-asset-allocation-between.html

Talking about FundAdvice.com, I would suggest Sound Investing podcast (http://www.fundadvice.com/sound-investing/). Larry Swedroe is a regular guest on that podcast and he was the guest speaker on August 28 show.