Total Stock vs Midcap vs Smallcap

[ps56k]

I have been trying to consolidate various funds from my Fidelity and TRowe holdings into my Vanguard account.
Also picked up the bible - Bogle's little book of investing common sense - just at chapter 1 & 2.

I can see the concept of the Total Stock fund - VTSMX - over very long term horizons,
but it's really hard not to tug at the portfolio with investing in sectors and asset classes...

At this point I have some Vanguard Midcap - VIMSX - and some TRowe Smallcap - PRNHX - holdings.
Can't decide if I should sell them, and add the money into my holding of Vanguard Total Stock fund. ?

It's interesting to note from the Yahoo chart - changing from 1, 2, or 5 year views -
that the small & mid do better in times of economic distress,
but when things look better, the total market pulls ahead.... and the Vanguard Total Bond just stays the course.

http://finance.yahoo.com/q/bc?s=VTSMX&t=2y&l=on&z=l&q=l&c=vimsx%2Cprnhx%2Cvbmfx

SO - depending upon how you stretch the chart rubber band, do midcap & smallcap have a place, or just go with the longer than 5 year view as per the little book, and toss all the equity into Total Stock Market - VTSMX ??

[stevewolfe]

I don't sweat the small stuff. Get your stock bond split right. Save as much as you can. Try and keep costs in total low. If that means you have some TSM (like I do) and a fund or two from T. Rowe Price or Fidelity (I own T. Rowe Price Capital Appreciation), I don't think it's a big mistake frankly. It's likely much more important to stay the course and try and keep the overall cost of the portfolio low.

[Taylor Larimore]

Ps56k:

SO - depending upon how you stretch the chart rubber band, do midcap & smallcap have a place, or just go with the longer than 5 year view as per the little book, and toss all the equity into Total Stock Market - VTSMX ??

Many investment experts without conflict of interest recommend total market index funds (which hold the market weight in "midcap and smallcap" stocks). You can read some expert recommendations HERE.

Before you "toss all the equity into Total Stock Market," and if your stocks are in a taxable account, you want to be sure to consider any capital gain tax.

There is more than one road to Dublin.

Best wishes.
Taylor

[Martindo]

I own sp500, midcap, and smallcap index funds in a taxable account. It's not the way I would design it right now, but it's what I have based on decisions made years ago, before I discovered Bogleheads. The tax costs of re-configuring this (e.g., to go to TSM) seem to me to be too high. The little green boxes on the Morningstar "market barometer" tell me this hasn't mattered much the last three years.

[Trev H]

ps56k..

If you are going to be a good "Lumper" --- investing in total market funds only...

You are going to just have to stop paying attention to things like this....

==
that the small & mid do better in times of economic distress,
but when things look better, the total market pulls ahead....
==

Good Luck !

Trev H

[pingo]

Perhaps this recent post by the well-regarded Nisiprius might interest you:

viewtopic.php?f=10&t=110089&newpost=1601587#p1600681

Disclosure: I do not have a set opinion as to whether one way is really better than the other. I'm a work in progress!

[stilts1007]

I prefer to have my assets broken up a little bit by class. Depending on who you listen to, there is some evidence that small-cap stocks may outperform overall market in the long run, so if you are planning on being invested long-term, it may give you a modest benefit. If you just want to set 1 allocation for the next 30 years and not have to thing about it, TSM may be a better bet. If you like to look (just look) and are OK with doing a little more rebalancing, it couldn't hurt to split up based on market cap.

[hpowders]

Small stocks may outperform the market at times. However, the inherent risk is great. The AAII has a small stock model portfolio and it was down over 50% in 2008.
Small stocks are too volatile for me. I'd rather go with smooth and steady.
I don't know many folks who could stay with a portfolio down 50%.

[Trev H]

hpowders...

Bear Market 2000-2002 and 2008 (facts).

TSM returns were -10.57, -10.97, -20.96, and in 2008 was -37.04 --- total return for those bear market years -79.54

Small Value returns were +21.88, +13.70, -14.20, and -32.05 --- total return for those bear market years -10.67

Small Value has the lowest correlation to the US Market and IMO the best way to hold it is a combination of US Large Market and Small Value.

I personally split my US equities 50/50 Large Cap Index, Small Value Index.

Also note that a very small increase in bond allocation (around 5%) completely eliminates the portfolio volatility issue resulting from such a equity mix.

Trev H

[Grt2bOutdoors]

hpowders...

Bear Market 2000-2002 and 2008 (facts).

TSM returns were -10.57, -10.97, -20.96, and in 2008 was -37.04 --- total return for those bear market years -79.54

Small Value returns were +21.88, +13.70, -14.20, and -32.05 --- total return for those bear market years -10.67

Small Value has the lowest correlation to the US Market and IMO the best way to hold it is a combination of US Large Market and Small Value.

I personally split my US equities 50/50 Large Cap Index, Small Value Index.

Also note that a very small increase in bond allocation (around 5%) completely eliminates the portfolio volatility issue resulting from such a equity mix.

Trev H

That may work for you, but for many investors who are fixated on the returns or lack thereof provided by each separate fund that allocation plan would likely spook them and cause them to liquidate at the most inopportune of times. Times when they should either be re-balancing using new cash or in a tax-deferred plan selling high and buying low. Many folks don't view their portfolio as one big pie instead they view it in isolation. Also, a 50/50 mix can lead to severe under/over performance - tracking error. Agree with other poster, TSM would alleviate two things - 1)the need to rebalance and 2)the microscopic viewing of the various asset classes in isolation, if it's all mixed up they will not be seeing SmV or MdV dropping by 20% while LC is up 10%.

[Trev H]

Grt2bOutdoors said...

==
they will not be seeing SmV or MdV dropping by 20% while LC is up 10%.
==

Please review again.... the actual returns for TSM and SV 2000-2002

TSM..... -10.57, -10.97, -20.96
SV....... +21.88, +13.70, -14.20

To go with your statement above... But they may actually see SV up 21.88% while TSM is down -10.57

Sure TSM is a smiple way to hold the Market (Beta)... but you have no size/price diversification.

If the individual can't stand to see different parts of his portfolio working differently over different periods of time - they better not be investing separately in stocks and bonds because they will sure be reacting differently over different periods of time. The only solution for them would be a all in one balanced fund.

If you can "get over that".... and invest in different components, then you can certinly come to realize that stocks and bonds will give different returns over differrent periods of time, and so will you individual stock and bond components (US, Intl, Large, Small, etc)... (Treasuries, Tips, Corps).

Trev H

[pingo]

Grt2bOutdoors said...

==
they will not be seeing SmV or MdV dropping by 20% while LC is up 10%.
==

Please review again.... the actual returns for TSM and SV 2000-2002

TSM..... -10.57, -10.97, -20.96
SV....... +21.88, +13.70, -14.20

To go with your statement above... But they may actually see SV up 21.88% while TSM is down -10.57

Sure TSM is a smiple way to hold the Market (Beta)... but you have no size/price diversification.

If the individual can't stand to see different parts of his portfolio working differently over different periods of time - they better not be investing separately in stocks and bonds because they will sure be reacting differently over different periods of time. The only solution for them would be a all in one balanced fund.

If you can "get over that".... and invest in different components, then you can certinly come to realize that stocks and bonds will give different returns over differrent periods of time, and so will you individual stock and bond components (US, Intl, Large, Small, etc)... (Treasuries, Tips, Corps).

Trev H

I am not against what Trev H suggests (I have learned a lot from your posts and threads), but I think Grt2bOutdoors points out important considerations of the way most people/new comers experience loss.

Eyeballing iShares Russel 2000 Value ETF (IWN) at M*, one would have had to stomach a drop in small value of ~62% from mid-2007 to the bottom of the crisis in March 2009, or a 57% drop in just less than 5 months from Sep 19, 2008 to the bottom of the crisis in March 2009.

Looking at returns year-by-year might not reveal the losses to be such, but in a time of crisis I think that most people would experience the losses as such.

[Clive]

For those that might not be familiar with the the relationship between arithmetic (simple average), standard deviation and annualised (geometric), have a look at Gummy's article http://www.gummy-stuff.org/AM-vs-GM.htm

Near the bottom of that page is a calculator, next to this image



Have a play and see how a higher standard deviation (volatility) results in smaller arithmetic results (and at the end of the day its the arithmetic (geometric) that investors actually get to spend).

Now consider that since 1927 (up to 2011) the rolling 10 year arithmetic average standard deviation for small cap value (SCV) was 30% compared to 17% for the S&P i.e. the volatility of SCV were a lot more volatile than the S&P. Plot those rolling 10 year averages and a degree of inverse correlation was also apparent i.e. they weren't both highly volatile at the same times.

Assuming a 2% inflation rate (Fed/BoE targets), Gummy's calculator indicates you'd have to have a 6.2% arithmetic average with a 30 stdev to get a 2% annualised. For the S&P's 17% stdev you only need a 3.4% arithmetic with 17% stdev to achieve the same 2% annualised.

If you hold only 57% exposure to an asset that had a 6.2% average, 30% standard deviation and stuffed the rest under a mattress, you'd have a combined portfolio that averaged (0.57 x 6.2) average = 3.54% average, with a (0.57x30) = 17% standard deviation. Which is similar in this example to having held 100% S&P.

Instead of a 50% weighting in S&P, you might hold 0.57x50 = 28.5% in SCV to similar effect and endure similar overall volatility. If the 21.5% remainder of funds not invested (rest of the 50% that would otherwise have been invested in the S&P) earn a reasonable return, or move counter direction to stocks, that might further bolster rewards/reduce risk.

You might say that around 30% SCV, is similar to holding 50% S&P. But those two don't track each other closely, so its more like two different stocks, that aren't highly correlated. In Japan post 1990 for example SCV have performed well, whilst their TSM has been dismal.

If 30% SCV provides similar reward to 50% S&P, then rather than a 50-50 portfolio of S&P with perhaps 5 year Treasury (bonds) you held 15% SCV, 25% S&P, 60% 5 year Treasury then according to SImba's backtest spreadsheet (which TrevH was a contributor) you achieved similar reward, but did so with significantly less portfolio risk (volatility) - something like 9.6% annualised with 8.4% stdev compared to 9.8% annualised with 18.2% stdev.

Small stocks may outperform the market at times. However, the inherent risk is great. The AAII has a small stock model portfolio and it was down over 50% in 2008.
Small stocks are too volatile for me. I'd rather go with smooth and steady.
I don't know many folks who could stay with a portfolio down 50%.

But if you only held 57% exposure to a -50% decline = 0.57 x -50 = -28.5%. And the remainder might have moved counter direction to reduce (make smaller) those losses further. 2008 50% TSM, 50% 5 year T endured a -11% in 2008, compared to 25% TSM, 15% SCV, 60% 5 year T declining -6%.

Have a look at this comparison - broadly similar results despite holding (some) SCV exposure.

One investor might opt to hold 30% SCV, 70% 5 year T as a proxy for 50-50 TSM/5 Year T. Another might opt to invest the 20% surplus from holding 30% SCV instead of 50% TSM in gold (20% gold). Yet another investor might opt to hold a STT/LTT barbell instead of 5 year T. Another might opt to hold 15% in a 2x (leveraged) SCV instead of 30% SCV....etc...etc. Which broadly are all subsets of Ben Graham's 50-50, with different names (Larry's Fat Tail Minimisation, Permanent Portfolio, Nassim Taleb's/Zvi Bodie's mostly safe, some highly speculative ...etc.). Just pick and stick with whichever is the most comfortable for you - according to which might be the most cost/tax efficient for you, and/or the better valued at the time of investing.

[Trev H]

If you are constantly fretting over the performance of individual components of your portfolil... well (IMO) you are just paying way toooooo much attention to your investments. You need to find someting better to do with your time.

I have been holding 50/50 mix of US Large Cap Index and Small Value Index for my US equity mix for many years now... and I have never even noticed one being more volatile than the other.

But it is a fact that I don't care about that, and don't even pay attention to that. It's not about the components - it's about the portfolio.

If you choose to hold asset components with higher expected return and volatility - focus on the bottom line (portfolio return) and as I mentioned earlier --- as you add high voliatiliy asset classes --- adjust your stock/bond allocation a bit to compensate. Example shown below.

The standard Lumper Portfolio at 60/40 vs what you might consider a extreme Slice/Dice (how I hold US equities) decreasing stock exposure by 10% increasing bond exposure by 10%.

Which portfolio was more volatile ? more risky ? did it matter (in the end results) if the SV component did a bit more zigging and zagging ?

NOPE !

Trev H

==

1970-2012

60% TSM, 40% Total Bond (annual rebalance).

10K Growth
$470,757.82
CAGR
9.37
StDev
11.47
Sharpe
0.41

Bear Market
1973……-9.70
1974……-13.72
2000……-1.79
2001……-3.21
2002……-9.27
2008……-20.20


25% TSM, 25% SV, 50% Total Bond (annual rebalance)

10K Growth
$601,599.80
CAGR
10.00
StDev
10.02
Sharpe
0.52

Bear Market
1973……-9.55
1974……-8.08
2000…… 8.52
2001…… 4.90
2002……-4.66
2008……-14.75

[Clive]

If you are constantly fretting over the performance of individual components of your portfolio... well (IMO) you are just paying way toooooo much attention to your investments.

+1

Relative performance of individual components is something that should be considered at the time of purchase, valuations matter. Beyond that its just noise

Take for instance if you were considering whether to opt for either a Permanent Portfolio or a Fat Tail Minimisation at present. Looking at just one measure of possible value - the log scaled historic price change of some of individual assets overlaid with its respective exponential regression (trend) line (right click and select view image for a larger view of the image)



Gold and Long dated treasury's are potentially above fair value at recent levels based on that measure, whilst small cap value despite having had a reasonable year last year is still below that particular choice of regression/trend.

There's a natural tendency to invest in assets that have exhibited recent historical good gains and shun others that might have performed less well, so you might expect more chatter about the Permanent Portfolio than FTM given more recent history. If I were starting today however I'd more likely go with FTM for its possible better value at recent levels. Gold having provided more recent strong gains (since early 2000's) and LTT yields being down at relatively low levels is less appealing as being good value than are shorter dated treasury's and SCV at the present time IMO.

Having loaded into one choice or another, worrying about how the other might have continued to relatively pull ahead etc. will only more likely make you want to jump ship - which can end up with you having swapped around at the worst possible times, buying relatively high, selling out relatively low to move into something else that you end up buying high/selling low. Rather you should be content that you did the best you could at the time of purchase in making that choice and see it through. Try and get in a contrarian mindset and perhaps only look to switch (if you must) perhaps when your existing choice looks relatively highly valued and there may be better value elsewhere. If more investors generally lose from doing the former (buying high/selling low), then the contrarian approach might capture some benefits from doing the complete opposite.