Paul A. Merriman
“I wish I had a dollar for every time I’ve heard Paul Merriman say ‘small cap value.’”
One of my readers posted that recently, perhaps meaning to poke fun at my repeated reference to this asset class.
But I make no apologies for being a fan, and a champion, of a class of stocks that over the long run have outperformed almost anything else you can invest in. And as I will assert below, small-cap value can actually reduce risks for long-term investors instead of adding to it. I’ll return to that topic; for now, remember the phrase “long-term.”
People who set money aside for retirement do so in order to make that money grow. It’s really pretty simple.
If you are planting a tree and want it to become very tall in your lifetime, you should plant a species that grows rapidly rather than one that’s slower. This is also pretty simple.
To continue that imperfect metaphor briefly, you could think of the S&P 500 index /zigman2/quotes/210599714/realtime SPX +0.75% (or the very similar U.S. Total Stock Market Index) as a species of tree that will grow three to 5 feet per year.
Likewise, small-cap value stocks might grow five to 7 feet a year.
If you planted those trees near each other, after 10 years you’d certainly notice the difference; after 20 years the difference would be striking.
From 1970 through 2020, the S&P 500 compounded at 10.7%. Small-cap value stocks compounded at 13.5%. Over one or two years, that wouldn’t make a lot of difference. But over a few decades — remember that phrase “long-term” — the difference would be very striking.
Imagine you could sock away $6,000 a year in an IRA for 40 years and retire for 30 more years. If you achieved even just an extra 0.5% long-term return, you would likely end up with $1 million more to spend in retirement and leave to your heirs.
Based on the long-term returns I just cited (10.7% for the S&P 500 and 13.5% for small-cap value), small-cap value could get you more than five times that $1 million difference.
The Merriman Financial Education Foundation has produced a year-by-year comparison of these two asset classes from 1970 through 2020.
This table shows you at a glance which asset class outperformed the other in each year — and by how much. For example, in 1984, the S&P 500 outperformed small-cap value by 4.3 percentage points. In 2006 — and again in 2012 — small-cap value outperformed by 5.8 percentage points.
The table also makes it clear why people who either lack a long-term perspective or who don’t understand diversification are shunning small-cap value right now: In every calendar year 2017 through 2020, the S&P 500 has done better. Small-cap value stocks didn’t lose money in those years; they just made less.
Fortunately, the choice between the S&P 500 and small-cap value isn’t an all-or-nothing decision.
This table has columns of returns showing year-by-year results for combinations of the S&P 500 and small-cap value in increments of 10 percentage points.