For many years, I’ve been recommending that investors do whatever they can to include small-cap value stocks in their retirement portfolios.
Even retirees should strongly consider overweighting their portfolios, at least to some extent, with small-cap value funds.
The statistical case for my recommendations has always been strong.
Now it’s stronger than ever, as I recently learned from Jeff Mattice, an engineer familiar with our work who has done some additional analysis of small-cap value investing.
Using data from Dimensional Fund Advisors, Jeff analyzed more than 90 years of returns, in some cases going back to 1926, for 14 equity asset classes.
In the U.S. market, these include large cap growth, large-cap blend, large-cap value, small-cap growth, small-cap blend, and small-cap value, as well as REITs.
His analysis includes the same asset classes for international markets, except emerging markets are substituted for REITs.
For each of these asset classes, Jeff studied every return period of one year, five years, 10 years, 15 years, 20 years, 30 years, and 40 years. That gives us a wealth of data on which of these asset classes performed the best and which performed the worst in all these short-term, mid-term and long-term periods.
The data are summarized in this table, which I recommend you study.
What leaps out at me from near the top of the table is one statistic: 53.7%. That indicates that over all these periods, small-cap value funds were likely more than half the time to have the very best performance of all these 14 asset classes.
Even in one-year periods, small-cap value stocks were likely to be the top performers nearly one-quarter of the time.
In fact, regardless of what time period you measure, small-cap value was by far the most likely to be the top-performing asset class, period.
And what was the worst-performing asset class?
As you can see in the table, in periods of one, three and five years, small-cap growth was by far the most likely to be the worst performing asset class; in periods of 10 years or more, large-cap growth was most likely to be the worst performer.
This underscores my longtime view that growth funds are not worth including even in a fully diversified portfolio. Instead, I prefer a combination of value funds and blend funds.
Because blend funds are made up of growth stocks and value stocks, this combination includes growth stocks, but it gives more weight to value stocks.
Small-cap stocks have the reputation of being particularly risky, but the statistics show that they were seldom the worst performer in any of these time periods.
If you’re a data wonk, you’ll want to study the Asset Class Index Descriptions at the bottom of the table. The data for some asset classes go back to the 1920s; the information we have for others start in the 1970s or later.
If you’re an investor trying to figure out the best way to deploy your money for retirement, you’ll likely wonder what you should do with this information.
As much as I am impressed with the history of small-cap value stocks, I don’t believe investors should put all their money in this asset class. (In some cases, young investors may be an exception.)
My wife and I have about 25% of our buy-and-hold equity investments in small-cap value funds. And we have another 25% in small cap blend funds that are about 50% value. We believe this gives us a significant boost in return without taking undue risk.
For more than 20 years, I have recommended that investors include 10 major equity asset classes in their retirement portfolios, and I still think this is excellent advice.
Small-cap value funds are only one of those asset classes. The others are large-cap blend, large-cap value, small-cap blend, REITs, and international funds that invest in large-cap blend, large cap value, small-cap blend, small-cap value, and emerging markets.
However, the historical data for U.S. small-cap value stocks is so strong that I think every investor should consider overweighting their portfolio with small-cap value.
There are several easy ways to do this.
If you have a 401(k) plan that does not include small-cap value funds, then it makes good sense to put some of your retirement savings into an IRA and invest that IRA in one or more small-cap value funds or ETFs.
That would give you the combination of a presumably balanced and well diversified portfolio in your 401(k) and an added boost from small-cap value in your IRA.
Many people invest in target-date retirement funds, and I have recommended in the past that people supplement those funds with small-cap value funds.
One of the most popular articles I’ve written over the last half dozen years has tracked the results of using only four U.S. asset classes in a retirement portfolio. These are large-cap blend, large-cap value, small-cap blend, and small-cap value.
As you can see in this article with updated information, such a four-fund portfolio has had good results, and that’s partly because small-cap value makes up 25% of the total.
Some investors may want to consider just investing in large-cap value and small-cap value. I think an all-value portfolio like that has much to recommend itself, particularly for younger investors with long investment horizons.
Whatever your situation, I think you will do yourself and your family a favor by making sure your investments include small-cap value stocks.
To learn more, check out my latest podcast, “A Huge Reason to Add Small Cap Value.” In it, I discuss why small-cap value stocks have produced such good returns and why I believe they are likely to keep doing so.
Richard Buck contributed to this article.