Long term market cap tilt with simple ratios

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jakehefty17
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Long term market cap tilt with simple ratios

Post by jakehefty17 » Thu Dec 06, 2018 12:52 am

Hi all,

Prelude: I am 27 years old, financially secure and have a long investment future ahead of me. I am posting this for opinions and suggestions on my asset allocation alone.

I've been looking at my asset allocation as the year draws to a close. I've had a pretty serious tilt into small and mid-cap stocks, and decided to look closer at the market caps and just how much I was tilting. Answer was more than I expected/wanted, so I decided that I should probably draw back. However, I do want to hold a long-term (stay the course) and well diversified tilt into mid and small cap domestically.

I decided I would attempt to boost market weight of mid and small cap allocation by about 50% each, shifting weight from large caps. Caps are weighted approximately 73:18:9 (Large:Mid:Small), so the resultant is an ugly (59.5:27:13.5). https://www.bogleheads.org/wiki/Approxi ... ock_market

Seeking something simpler, I decided to try a 4:2:1 weighting. This leads to approximately 57% large cap, 29% mid, and 14% small (a boost between 55-60% weight for both mid and small). This shifts about 20% of the large cap market weight (or 16% total market weight) into mid and small caps.

Here's where things get interesting. Between Bogle and Vanguard, the recommended international allocation is between 20-40% foreign markets. Splitting the difference gives us 30% of equities.

Adding this to the 4:2:1 Domestic allocation gives us 10 parts, and simplicity within the stock portfolio. 40% Large Cap, 30% All-World Ex-US, 20% Mid Cap, 10% Small Cap. I plan to increase bond allocation by 10% every 10 years, and this ratio works well for keeping the allocation relatively simple.

So here are the questions:
1) What is your opinion on shifting market weight as I am suggesting?
2) Should I consider a 2:1 split on international between Developed and Emerging Markets?
3) As far as tilting is concerned, would you consider this a simplified approach?
"The problem with the world is that the intelligent people are full of doubts, while the stupid ones are full of confidence." -Charles Bukowski

andrew99999
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Re: Long term market cap tilt with simple ratios

Post by andrew99999 » Thu Dec 06, 2018 2:43 am

Tilting away from market cap always comes back to the same questions

1. What you are doing is increasing your allocation to higher risk higher return assets. There is no free lunch here. If you intended to increase your overall risk, why not just increase your overall equity exposure instead? If you did not intend to increase your overall risk you can lower your equity exposure and stick with this allocation, but more to the point, why, if you just shift it back you get pretty much the same risk/return profile. What is the actual reason you want to tilt this way? I didn't see any reason given.

2. The market has determined the values of these companies. By changing from market cap, you are saying that you know more than the market. Can you please tell me what you know that the market doesn't?

3. If you want to tilt (in any direction), and your tilt under performs over a decade or more which is not uncommon for these higher risk higher return classes, will you really have the conviction to continue holding on indefinitely after it his appeared to have proven (in the eyes of everyone else) that it is permanently an under performer? If there is a chance you will give up on it and sell when it has under performed, then you have made a loss compared to not tilting in the first place.

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jakehefty17
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Re: Long term market cap tilt with simple ratios

Post by jakehefty17 » Thu Dec 06, 2018 3:23 am

andrew99999 wrote:
Thu Dec 06, 2018 2:43 am
Tilting away from market cap always comes back to the same questions

1. What you are doing is increasing your allocation to higher risk higher return assets. There is no free lunch here. If you intended to increase your overall risk, why not just increase your overall equity exposure instead? If you did not intend to increase your overall risk you can lower your equity exposure and stick with this allocation, but more to the point, why, if you just shift it back you get pretty much the same risk/return profile. What is the actual reason you want to tilt this way? I didn't see any reason given.

2. The market has determined the values of these companies. By changing from market cap, you are saying that you know more than the market. Can you please tell me what you know that the market doesn't?

3. If you want to tilt (in any direction), and your tilt under performs over a decade or more which is not uncommon for these higher risk higher return classes, will you really have the conviction to continue holding on indefinitely after it his appeared to have proven (in the eyes of everyone else) that it is permanently an under performer? If there is a chance you will give up on it and sell when it has under performed, then you have made a loss compared to not tilting in the first place.
Thank you for your reply!

1. I understand that risk will increase. One reason for slice/dice into mid and small cap indexes specifically is for better exposure. These indexes are broader than a typical total market fund. Also, my 401k offers better cap-weighted options (Actually no total-market fund).

2. I'm not saying I know more than the market. The thought is that over a long investment period, the added risk may add more return. I'm sharing these thoughts to gather opinions.

3. If the entire small and mid cap indexes are under-performing for a decade, I still wouldn't sell. 2-3 more decades until retirement. I do see the point you are making.

I appreciate the criticisms and was expecting some. We're still talking about indexed, broadly diversified funds. I was happy to land on some nice even ratios and shared how I got there. I want to tilt and still have an air of simplicity to facilitate long-term holding. Am I being unreasonable?

In your opinion, is a 16% market weight shift out-of-line or an acceptable long-term tilt?
"The problem with the world is that the intelligent people are full of doubts, while the stupid ones are full of confidence." -Charles Bukowski

andrew99999
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Re: Long term market cap tilt with simple ratios

Post by andrew99999 » Thu Dec 06, 2018 4:30 am

jakehefty17 wrote:
Thu Dec 06, 2018 3:23 am
In your opinion, is a 16% market weight shift out-of-line or an acceptable long-term tilt?
If you really can hold for 30 or 40 years then tilting towards SC, SCV, EM probably will have a higher return due to the higher risk, and it doesn't seem unreasonable to me, but my opinion isn't relevant, I was just pointing out the pitfalls so that your decision is based on as much information as possible.

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jakehefty17
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Re: Long term market cap tilt with simple ratios

Post by jakehefty17 » Thu Dec 06, 2018 4:51 am

andrew99999 wrote:
Thu Dec 06, 2018 4:30 am
If you really can hold for 30 or 40 years then tilting towards SC, SCV, EM probably will have a higher return due to the higher risk, and it doesn't seem unreasonable to me, but my opinion isn't relevant, I was just pointing out the pitfalls so that your decision is based on as much information as possible.
Your opinion is relevant to me! Thanks again for replying.
"The problem with the world is that the intelligent people are full of doubts, while the stupid ones are full of confidence." -Charles Bukowski

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vineviz
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Re: Long term market cap tilt with simple ratios

Post by vineviz » Thu Dec 06, 2018 11:51 am

jakehefty17 wrote:
Thu Dec 06, 2018 12:52 am
So here are the questions:
1) What is your opinion on shifting market weight as I am suggesting?
My view is that the US allocation is still unnecessarily complicated. In a portfolio that holds both large and small cap stocks, a fund dedicated to mid cap stocks is almost entirely redundant. The diversification benefits of a 4:2:1 ratio of large/mid/small cap US stocks can easily be replicated with a simpler 3:2 or 2:1 mix of large/small.

https://www.portfoliovisualizer.com/bac ... pBlend3=40
jakehefty17 wrote:
Thu Dec 06, 2018 12:52 am
2) Should I consider a 2:1 split on international between Developed and Emerging Markets?
Such a split is about optimal from a diversification perspective: historically the best risk/reward tradeoff has been at 30% to 40% international, and 2:1 puts you right in the middle.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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patrick013
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Re: Long term market cap tilt with simple ratios

Post by patrick013 » Thu Dec 06, 2018 12:57 pm

jakehefty17 wrote:
Thu Dec 06, 2018 12:52 am

So here are the questions:
1) What is your opinion on shifting market weight as I am suggesting?
2) Should I consider a 2:1 split on international between Developed and Emerging Markets?
3) As far as tilting is concerned, would you consider this a simplified approach?
Backtest Portfolio Asset Allocation = https://www.portfoliovisualizer.com/bac ... ion9_3=100

Backtesting would help. In a recent 20 year period MC Value was the best performer in Russell's general indexes. So I weight SC, MC, and LC equally. They are all good companies so I give them that much chance to perform. I'm not a fan of Intl so not alot to comment about there.
age in bonds, buy-and-hold, 10 year business cycle

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jakehefty17
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Re: Long term market cap tilt with simple ratios

Post by jakehefty17 » Thu Dec 06, 2018 7:45 pm

Thank you both for your replies, I need to explore that portfolio visualizer tool.
vineviz wrote:
Thu Dec 06, 2018 11:51 am
jakehefty17 wrote:
Thu Dec 06, 2018 12:52 am
So here are the questions:
1) What is your opinion on shifting market weight as I am suggesting?
My view is that the US allocation is still unnecessarily complicated. In a portfolio that holds both large and small cap stocks, a fund dedicated to mid cap stocks is almost entirely redundant. The diversification benefits of a 4:2:1 ratio of large/mid/small cap US stocks can easily be replicated with a simpler 3:2 or 2:1 mix of large/small.

https://www.portfoliovisualizer.com/bac ... pBlend3=40
That's an interesting point. I was still trying to hold some semblance of the market weights, which would include mid caps. Makes me think of Mel's Unloved Midcaps... viewtopic.php?t=169637

Anyway thanks again. I like this allocation and it's simple enough that I can see myself sticking with it.
"The problem with the world is that the intelligent people are full of doubts, while the stupid ones are full of confidence." -Charles Bukowski

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Socrates28
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Re: Long term market cap tilt with simple ratios

Post by Socrates28 » Thu Dec 06, 2018 8:04 pm

Such a split is about optimal from a diversification perspective: historically the best risk/reward tradeoff has been at 30% to 40% international, and 2:1 puts you right in the middle.
I wouldn't waste your time with international (maybe small value).....correlated with US and crappy returns

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galeno
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Re: Long term market cap tilt with simple ratios

Post by galeno » Thu Dec 06, 2018 9:10 pm

I'm thinking along the same lines.

Right now we use ONE FTSE all world equity ETF (VWRD:LSE):

52% Giant + 34% LC + 14% MC + 0% SC.

To mirror the FTSE all cap all world equity index (VT) we would have to use 88.5% VWRD + 12.5% WSML (MSCI World Small Cap Index):

46% Giant + 30% LC + 19% MC + 5% SC.

If we use 75% VWRD + 25% WSML:

39% Giant + 26% LC + 24% MC + 11% SC.

We're definitely going for VT-like capitalization. Maybe will go with the slight MC/SC tilt. I haven't' decided yet.
AA = 40/55/5. Expected CAGR = 3.8%. GSD (5y) = 6.2%. USD inflation (10 y) = 1.8%. AWR = 4.0%. TER = 0.4%. Port Yield = 2.82%. Term = 33 yr. FI Duration = 6.0 yr. Portfolio survival probability = 95%.

averagedude
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Re: Long term market cap tilt with simple ratios

Post by averagedude » Thu Dec 06, 2018 10:48 pm

Im sure many will disagree with me but this is my answers to your questions. Since you are 27, im assuming you are going to have a 40+ year time horizon.
1. As far as market cap, 70:20:10, 60:20:20, 50:25:25, or even 34:33:33 is a reasonable tilt. Probably wont increase or decrease your long term returns more than 0.5% annually. Of course over 40 years, 0.5% comes out to alot of money.
2. As far as developed/emerging, 2:1 is reasonable and is about what i have. 80:20 is the market. Me personally anything over 50% in emerging would make me uncomfortable.
3. As far as complexity, doing the math to rebalance is easy if you know how to add, subtract, multiply, and divide. It will take you about 20 minutes a year to do this though.
Keep in mind your biggest enemy is yourself. Over 40 years you will have asset classes that will have a decade of underperformance. Can you stay the course without changing? Are you willing to sell something that is performing well and buy something that isnt? Are you comfortable if your strategy underperforms the market?These are several questions of many that you need to ask yourself before tilting your portfolio.

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jakehefty17
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Re: Long term market cap tilt with simple ratios

Post by jakehefty17 » Fri Dec 07, 2018 1:46 am

averagedude wrote:
Thu Dec 06, 2018 10:48 pm
3. As far as complexity, doing the math to rebalance is easy if you know how to add, subtract, multiply, and divide. It will take you about 20 minutes a year to do this though.
Maybe I'm extra lazy but I was happy not to need decimal places :) . My 401k only allows for fund allocation to full percentages, no decimals.

As for being able to sell high and buy low, I like to believe I will have the nerve to do so. My 401k will automatically rebalance semi-annually. I feel confident in my asset allocation and can stick to it... the way I see it I'm not even tilting to value or growth. Cap weighting is relatively benign IMO.

In the future I'll need to rebalance my taxable (which I plan to invest quarterly, hopefully helping maintain asset allocation) and Roth IRA (through vanguard) myself. The nicer the numbers the easier it will be on me!
galeno wrote:
Thu Dec 06, 2018 9:10 pm
I'm thinking along the same lines.

We're definitely going for VT-like capitalization. Maybe will go with the slight MC/SC tilt. I haven't' decided yet.
Nice to see I'm not the only one!

Thanks for replying.
"The problem with the world is that the intelligent people are full of doubts, while the stupid ones are full of confidence." -Charles Bukowski

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