TIlting to small cap - how much is too much?

[pistolpete]

I'm about to start my first attending job, and I'm working on my asset allocation. I'm 31 and expect to go half time around age 55 and retire at 60. Would like to have about $4mill in the bank at age 60. I'll be using a Schwab account for my Roth, 401k and 457b governmental, while at the government job and eventually just have my solo 401k and a taxable account. Expense ratios are in brackets. My thoughts are:

90% stocks, 10% bonds and cash

Stocks:

60% US: 30% large cap (SCHX, 0.03%), 30% small cap (SCHA, 0.05%)

20% International: 15% international (SCHF, 0.06%), 5% emerging markets (SCHE, 0.13%)

10% REIT (SCHH, 0.07%)

Am I tilting too much towards small cap? Should I just leave the 60% stocks in a total stock market index fund and be done with it?

[jfoxcpacfp]

Your equity allocation is close to what we use (although 100% overall). I would further divide the LC and the SC into 50% growth and 50% value. If you use a blended fund, you're going to end up with more bonds. Be sure to rebalance back to beginning parity annually (at about the same time of year).

[VagabondMD]

30% is okay, but 30% to small value would be even more desirable, in order to also take advantage of the value premia.

[pistolpete]

jfoxcpacfp wrote:

Your equity allocation is close to what we use (although 100% overall). I would further divide the LC and the SC into 50% growth and 50% value. If you use a blended fund, you’re going to end up with more bonds. Be sure to rebalance back to beginning parity annually (at about the same time of year).

Click to expand...

Aren't large-cap and small-cap funds already part growth and part value? Or am I mistaken?

[WallStreetPhysician]

pistolpete wrote:

I’m about to start my first attending job, and I’m working on my asset allocation. I’m 31 and expect to go half time around age 55 and retire at 60. Would like to have about $4mill in the bank at age 60. I’ll be using a Schwab account for my Roth, 401k and 457b governmental, while at the government job and eventually just have my solo 401k and a taxable account. Expense ratios are in brackets. My thoughts are:

90% stocks, 10% bonds and cash

Stocks:

60% US: 30% large cap (SCHX, 0.03%), 30% small cap (SCHA, 0.05%)

20% International: 15% international (SCHF, 0.06%), 5% emerging markets (SCHE, 0.13%)

10% REIT (SCHH, 0.07%)

Am I tilting too much towards small cap? Should I just leave the 60% stocks in a total stock market index fund and be done with it?

Click to expand...

This is a reasonable asset allocation. Small cap, as I'm sure you know, is associated with higher expected (but not guaranteed) returns with higher risk / volatility. If you can handle the extra volatility, your small cap allocation is perfectly reasonable.

-WSP

[artemis]

pistolpete wrote:

Aren’t large-cap and small-cap funds already part growth and part value? Or am I mistaken?

Depends on the fund.  Some tilt toward growth, some toward value, and some are a blend of both.

[jfoxcpacfp]

pistolpete wrote:

Aren’t large-cap and small-cap funds already part growth and part value? Or am I mistaken?

Click to expand...

Not necessarily. Looking at a few of the funds we use,

• HRSCX, Eagle Small Cap Growth Fund Class A, is SC Growth. (Ignore the A class, as we do not impose loads.)


• VHDYX, Vanguard High Dividend Yield Index Fund, is LC Value.


• FSCRX, Fidelity Small Cap Discovery Fund, is SC Blend - tilted toward Value but with Growth stocks in the mix, also.

[pistolpete]

artemis wrote:

pistolpete wrote:

Aren’t large-cap and small-cap funds already part growth and part value? Or am I mistaken?

Depends on the fund.  Some tilt toward growth, some toward value, and some are a blend of both.

Click to expand...

So looking at the Schwab small-cap ETF (SCHA), it's a blend. Expense ratio is great at 0.05%. Would I really gain that much by subdividing this into small cap value (SLYV, which is SPDR S&P 600 Small Cap Value ETF, 0.15%) and small cap growth (SLYG, which is SPDR® S&P 600 Small Cap Growth ETF, 0.15%)?

The small cap value and growth are higher expense ratio and at Schwab are not comission-free, which I think would be the main problem and why I'm leaning to just keeping small cap core.

[Zaphod]

pistolpete wrote:

artemis wrote:

pistolpete wrote:

Aren’t large-cap and small-cap funds already part growth and part value? Or am I mistaken?

Depends on the fund.  Some tilt toward growth, some toward value, and some are a blend of both.

Click to expand…

So looking at the Schwab small-cap ETF (SCHA), it’s a blend. Expense ratio is great at 0.05%. Would I really gain that much by subdividing this into small cap value (SLYV, which is SPDR S&P 600 Small Cap Value ETF, 0.15%) and small cap growth (SLYG, which is SPDR® S&P 600 Small Cap Growth ETF, 0.15%)?

The small cap value and growth are higher expense ratio and at Schwab are not comission-free, which I think would be the main problem and why I’m leaning to just keeping small cap core.

Click to expand...

Its questionable in the first place whether tilting to something like small cap, which everyone knows and does it seems, ever actually worked in the first place. There were a ton of definition changes and index mergers over the last 100 years that resulted in quite the on paper out performance of this asset class that is nearly totally attributable to these changes and not some premium. Any actual premium is not in small cap, but in value as later research has shown it to be.

I think all the over slicing isnt worthwhile at all unless you tacitly admit to yourself you will be doing some sort of explicit timing, that is you will buy reits when they have been getting crushed for a while, EM, international all based on some sort of relative value. Otherwise probably a similar return, much simpler to just have a total, international, and some bond fund.

[pistolpete]

Zaphod wrote:

pistolpete wrote:

artemis wrote:

pistolpete wrote:

Aren’t large-cap and small-cap funds already part growth and part value? Or am I mistaken?

Depends on the fund.  Some tilt toward growth, some toward value, and some are a blend of both.

Click to expand…

So looking at the Schwab small-cap ETF (SCHA), it’s a blend. Expense ratio is great at 0.05%. Would I really gain that much by subdividing this into small cap value (SLYV, which is SPDR S&P 600 Small Cap Value ETF, 0.15%) and small cap growth (SLYG, which is SPDR® S&P 600 Small Cap Growth ETF, 0.15%)?

The small cap value and growth are higher expense ratio and at Schwab are not comission-free, which I think would be the main problem and why I’m leaning to just keeping small cap core.

Click to expand…

Its questionable in the first place whether tilting to something like small cap, which everyone knows and does it seems, ever actually worked in the first place. There were a ton of definition changes and index mergers over the last 100 years that resulted in quite the on paper out performance of this asset class that is nearly totally attributable to these changes and not some premium. Any actual premium is not in small cap, but in value as later research has shown it to be.

I think all the over slicing isnt worthwhile at all unless you tacitly admit to yourself you will be doing some sort of explicit timing, that is you will buy reits when they have been getting crushed for a while, EM, international all based on some sort of relative value. Otherwise probably a similar return, much simpler to just have a total, international, and some bond fund.

Click to expand...

Point taken. Thanks!

[VagabondMD]

jfoxcpacfp wrote:

pistolpete wrote:

Aren’t large-cap and small-cap funds already part growth and part value? Or am I mistaken? 

Click to expand…

Not necessarily. Looking at a few of the funds we use,

• HRSCX, Eagle Small Cap Growth Fund Class A, is SC Growth. (Ignore the A class, as we do not impose loads.)


• VHDYX, Vanguard High Dividend Yield Index Fund, is LC Value.


• FSCRX, Fidelity Small Cap Discovery Fund, is SC Blend – tilted toward Value but with Growth stocks in the mix, also.

Click to expand...

I am surprised to learn that you use actively managed funds for client accounts. May I inquire as to what is your rationale? I also do, for a small portion of my portfolio, but this approach is very unpopular in this neck of the woods.

[jfoxcpacfp]

Vagabond MD wrote:

jfoxcpacfp wrote:

pistolpete wrote:

Aren’t large-cap and small-cap funds already part growth and part value? Or am I mistaken?

Click to expand…

Not necessarily. Looking at a few of the funds we use,

• HRSCX, Eagle Small Cap Growth Fund Class A, is SC Growth. (Ignore the A class, as we do not impose loads.)


• VHDYX, Vanguard High Dividend Yield Index Fund, is LC Value.


• FSCRX, Fidelity Small Cap Discovery Fund, is SC Blend – tilted toward Value but with Growth stocks in the mix, also.

Click to expand…

I am surprised to learn that you use actively managed funds for client accounts. May I inquire as to what is your rationale? I also do, for a small portion of my portfolio, but this approach is very unpopular in this neck of the woods.

Click to expand...

That's a great question. We use both, actually. We began using actively-managed funds years ago. Just under a year ago, we made the conscious decision to change to index funds for all new clients - all physician clients have index funds because it is so popular in "this neck of the woods". Because all clients haven't been through a rebalancing cycle yet, our original clients still have a mixture of both. We don't make hasty changes around here - that, also, can negatively impact our clients' portfolios.

But to address your question on why we use or have used actively-managed funds, and not to start a huge debate, our focus is always on the plan and maintaining the portfolio as a servant of the plan, investing for the long term only, planning liquidity for the short term, communicating with clients to ensure that their plans have not changed, and so forth. Our experience and belief is that having the appropriate diversification, rebalance schedule, and consistent behavior is a much higher priority over the active v. passive debate. That is a big ho-hum for me.

Cost plays a part, all other things being equal, but it is not the priority for optimal long-term returns. However, the examples I see on this and other sites assumes all of the above elements are in place when they focus on cost. Bloggers construct portfolios comparing index funds and funds with above-index fund costs or with the investor paying a 1% AUM fee and calculate the cost out until retirement, assuming all other factors are in perfect order. Running out a scenario comparing costs isn't too difficult and makes for a stunning piece of Ah ha! journalism.

I personally believe this is harmful to readers because of the false sense of security engendered that, if investors will simply use index funds and avoid paying advisors, they will be able to replicate the market or at least have marvelous results. The reality is not that pretty nor easy to pull off - and it's not because they use high-cost funds. [Unfortunately in our industry, many investors would have been better off w/o an advisor because of the number of snakes and well-meaning but inexperienced advisors - but that's another story.]

All things being equal, I'm happy to use index funds. We made the decision to change because of the sentiments of this forum, not because we necessarily believed it would make a significant difference in the long-term returns of our clients' portfolios. While it may make us look good to follow the crowd, in reality we know what really makes the long-term difference in our clients' returns - and it's not index funds.

[VagabondMD]

^^

Thank you for the well-thought and excellent response.