Bulletin
Investor Alert

Outside the Box

Sept. 18, 2021, 7:59 p.m. EDT

Why this fund combination is better than the S&P 500

new
Watchlist Relevance
LEARN MORE

Want to see how this story relates to your watchlist?

Just add items to create a watchlist now:

  • X
    S&P 500 Index (SPX)

or Cancel Already have a watchlist? Log In

Paul A. Merriman

Continued from page 1
Page 1 Page 2

For example, if you wanted most of your investments in the S&P 500 but with a boost to get you twice that 0.5% extra long-term return, you could have achieved that with a combination of 70% in the S&P 500 and 30% in small-cap value. That mixture had a compound return of 11.7%.

Now let’s return to the topic of risk. For statisticians, risk might look like standard deviation. But for investors, risk is about losing money.

Here are two very valid questions: How much would you have lost in the worst 12 months if you were 100% in the S&P 500? And how much if you were in the 70/30 combination I just described?

Neither answer is pretty. The worst 12 months of the S&P 500 was a loss of 43.3%; for the 70/30 combination, the loss was 45.1%.

Obviously, that made the 70/30 combo riskier mathematically.

But I doubt that many investors who were willing to tolerate a loss of 43.3% (the S&P 500) would then suddenly bail out after another 1.8 percentage points of loss from small-cap value stocks.   

The table also contains these tidbits of information: Of these 51 calendar years, the S&P 500 did better in 24 years, by an average of 11 percentage points. Small-cap value, on the other hand, did better in 27 calendar years, by an average of 16.8 percentage points.

Small-cap value investors should not expect their returns to be similar to the S&P 500. In the past 51 years, the calendar-year returns of these two asset classes were within 5 percentage points of each other only eight times. In nine years, the difference was more than 25 percentage points.

Personally I’m always curious about how many calendar years result in a loss. Over this period, the S&P 500 lost money in 10 years (average loss = 14.1%); small-cap value lost money in 12 years (average loss = 14.5%).

But here’s something I think is much more important, something that should get the attention of every long-term investor:

An extremely risky period for equity investors in recent memory was 2000-2002, which came right after a five-year bull market in which the S&P 500 achieved a compound return of 28.6%.

Investors naturally thought this would continue.

But in 2000, the index lost 9.1%. Then in 2001 it lost another 11.9%. As if to wake up investors who hadn’t noticed, the S&P 500 then lost still another 22.1% in 2002.

In those same three years, small-cap value gained 21.3%. This sort of thing is how investors benefit from diversification.

Although the future won’t duplicate the past, there is virtually no disagreement from the experts that over the long term, higher returns are correlated with higher risks.

If you’re setting money aside for a month, a year or even just a few years, you should be more concerned with risk than with potential returns.

But if you are saving for retirement, you should seek higher long-term returns, as long as you can tolerate the short-term risks that go with them.

For more on this topic of the S&P 500 and small-cap value, I’ve recorded a podcast .

Also, I’m scheduled to make a presentation, “Twenty Things You Should Know About Small Cap Value,” at the upcoming two-day virtual American Association of Individual Investors Conference .

Richard Buck contributed to this article .

Paul Merriman and Richard Buck are the authors of We’re Talking Millions! 12 Simple Ways To Supercharge Your Retirement .

Page 1 Page 2
This Story has 0 Comments
Be the first to comment
More News In
Retirement

Story Conversation

Commenting FAQs »

Partner Center

Link to MarketWatch's Slice.