My thoughts on Small-Cap and Value Stocks

People have often asked me what I think about value and small-cap equity portfolios. So, this is a post I always wanted to write but kept postponing because I never knew how to best frame it. But now I have the perfect excuse to write it; last week, I listened to the ChooseFI podcast and they had Paul Merriman as a guest in episode 130. Paul Merriman is one of the big proponents of small-cap and value stocks. Of course, they talked about a variety of topics and I thoroughly enjoyed most of the discussion. I’m completely on the same page with Paul, Jonathan and Brad on a wide range of issues. For example:

  • Choose index funds over actively managed funds
  • Take emotions, especially fear and greed out of investment decisions
  • Young investors benefit from Dollar Cost Averaging. Specifically, a market crash early in your investing life can even be beneficial, at least under specific assumptions, as I wrote earlier this year in “How can a drop in the stock market possibly be good for investors?
  • Young investors shouldn’t even think about bonds in the portfolio when starting out. Use 100% equities, use as much risk as possible.

But there’s one thing I vehemently disagreed with! Paul Merriman seems to suggest that by using a “better” or “smarter” equity allocation, specifically, overweighting the value and small-cap styles – both domestically and internationally – we can increase our expected return by two full percentage points a year. And just to be sure, this is not stock picking but simply asset class/style picking, all implemented with passive ETFs. Two percentage points of extra return? Let that sink in! 2% a year can compound to a large sum over the years and then you retire and you get extra 50% of withdrawals when you add 2 percentage points to your 4% safe withdrawal rate. Pretty impressive! There’s only one problem: Merriman’s recommended portfolio didn’t return those two extra percentage points over the past few decades. And there are good reasons to believe that you will not gather those 2% extra returns going forward either. Let me explain why… Continue reading “My thoughts on Small-Cap and Value Stocks”

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