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tony

3 Cheers For Sloth and Simplicity

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We have a work ethic problem. Too much of it.

Lots of people think that if they work hard and long, if they grunt and puff, if they demonstrate serious mental effort, if they read copiously and take notes — if they do all those things — they will be successful investors.

Not so. Read more here

https://www.dallasnews.com/business/personal-finance/2020/01/19/three-cheers-for-sloth-and-simplicity/

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Bogle would have loved this two fund portfolio. He didn't much care for Internationals. I'm more a 4 fund portfolio guy adding some extra small caps to the mix because Total Stock Market Index has limited exposure to smaller companies. Some purchase an extended market index fund to add diversity. But a two fund portfolio can do very well as pointed out in the article.

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14 hours ago, tony said:

I'm more a 4 fund portfolio guy adding some extra small caps to the mix because Total Stock Market Index has limited exposure to smaller companies. 

Just to add clarity for other people reading this...

A total market fund (like VTSAX) invests in large, medium, and small companies based on the share of the US market that those companies represent. One point of nuance...this split isn't based on the sheer number of companies (there are far more small companies than large); it is based on the value of companies (large companies are far more valuable than small companies).

So if Apple is valued at 3% of the entire US economy then 3% of a total market fund will be invested in Apple. Similarly, if Small Company ABC represents 0.000000000001% of the US economy then 0.000000000001% of the fund will be invested in Small Company ABC. Therefore a total market fund's investment in small companies is exactly equal to their value in the US economy (roughly 5%).

If people buy additional funds with a focus on small companies, they're doing something referred to as "tilting," which is a fancy way of saying they are betting that small companies are undervalued and they believe a period of over-performance (relative to medium and large companies) is on the horizon. Said another way, this is a form of market timing and prediction, which is something I highly discourage. The bet may or may not pay off, whose to say?

Although I wouldn't go down this road, I don't think it's terrible as long as you stick with it forever and only use low cost index funds to implement it.

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This is not market timing.  This  is diversification and buying and holding.It's simply balancing 'further diversifying" The Total Market Index which tilts more to larger companies. My index small cap  fund has outpaced all my other index funds  for two decades.  Its added  not subtracted.This method does work in theory and has been discussed in research. I'm not encouraging it. I  mostly encourage target funds for most folks who post here. But even there many are not  3 fund portfolios. Frankly the worst performing class has been internationals for me over time. I could easily eliminate it and be fine even though it's often heavily promoted as essential.

Ed you are an investment puritan to the extreme. Nothing wrong with that but nothing wrong with what I am doing either. If a newbie decided to add a small cap index component to your  3 fund portfolio, I seriously doubt their sky would fall.Should I start calling you  John Bogle Jr. ? Incidentally John Bogle's real son runs a managed fund outfit LOL!!

 

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53 minutes ago, tony said:

The Total Market Index which tilts more to larger companies.

By definition the total market index doesn't tilt toward anything. It invests based on market capitalization. If you tweak that by adding a small cap fund then you're adding a tilt rather than correcting a tilt.

53 minutes ago, tony said:

My index small cap value fund has outpaced all my other index funds by a mile and a half for two decades.

I can always find specific funds or asset classes that outpaced the total market index (diversification vs concentrated risk). Past performance doesn't predict future performance. This line of thinking is literally representative of the argument between index vs active.

Still, your statement doesn't provide an accurate representation of the past. If you use morningstar to chart small cap vs the total market you'll find that there are relatively small periods of time where the small caps really outperformed. I think most of the time small caps were coming out tied or behind (but I stopped looking at historical data around the 90s), but thanks to that period of overperformance (depending on when you invested) you may have come out ahead. Although the total market has dominated the last decade, especially recently:

  • 2019: 30.84% vs 27.35%
  • 2018: -5.17% vs -9.33%
  • 2017: 21.19% vs 16.24%
  • 2016: 12.68% vs 18.26%
  • 2015: 0.4% vs -3.68%
  • 2014: 12.58% vs 7.54%

We can cherry pick specific time segments when small caps won or lost relative to the total market index. Bogle never heard persuasive evidence for why small caps would predictably outperform in the future (i.e. the market currently undervaluing them and then correcting) and he discouraged people from tilting; so do I. However, the main point here is that if you're going to tilt then you need to know you will have years/decades where it doesn't go your way and if you can't stick with your plan for life then you're very likely to come up a loser.

53 minutes ago, tony said:

 Its added  not subtracted.

Again, it depends on what time frame you're looking at.

53 minutes ago, tony said:

Frankly the worst performing class has been internationals for me over time. I could easily eliminate it and be fine even though its often heavily promoted as essential.

By definition a diversified portfolio will always have winners and losers. This temptation to eliminate the losers is how you move away from diversification and start pumping money into assets that are at their peaks while pulling money out of assets at their lows. Although tempting, this is usually a disaster.

We all have to accept that we can't predict the future and we see patterns where they don't exist.

53 minutes ago, tony said:

Ed you are an investment puritan to the extreme. Nothing wrong with that but nothing wrong with what I am doing either.

The point of my post was to highlight that the total market fund is not over or under invested in anything. If you build a portfolio that is over or under invested in something then you are placing a bet. You're saying that the market currently has something (small cap) valued at Z% and you think that the market is going to "correct" this "undervalued" asset and shift to Y%. That's a bet.

As I said as long as somebody makes this bet in moderation, uses low cost index funds, and sticks with the strategy until death, then I think they'll basically be fine. This is particularly true when the bet is on something as broad as small cap companies as opposed to something as narrow as Snapchat. However, don't fool yourself into thinking your not making a bet or you're correcting an unbalanced total market fund.

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8 minutes ago, tony said:

I no longer need to offer my opinions  on this site any further  since you are now the resident expert.  

Offer your opinions all day long. If you find incorrect data or faulty logic in my posts then point it out and I'll happily concede and update my world view.

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Although I feel this is splitting hairs and I have never heard anyone say they did not meet their financial goals because they did not have a tilt towards small cap value in their portfolio, I think there is some good academic research that makes it worth considering having a small tilt to a small cap value index fund. See studies of Fama and French. Fees however must be considered as always.

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It is a verifiable fact that in the past people have seen better results with portfolios that disproportionately invest in small caps.

Although as Bogle pointed out in one of his books, literally every investment scheme people preach is guaranteed to work well with prior data. If these schemes didn't backtest well, it would be quite difficult to sell something that's been a historic failure. The argument Bogle goes on to make (and I agree) is that the overperformance in particular asset classes or investment approaches is likely due to one of two things:

  1. Pure random chance and we're seeing a pattern where one doesn't exist (something that humans are notorious for, think of how many shapes you can see in clouds for example).
  2. A strategy that wasn't lucky, but worked in the past due to conditions that are no longer present or explainable.

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