This article originally appeared at Forbes as It Pays to Diversify Beyond the S&P 500 by Robert Schmansky, CFP®.
Investors often ask if an approach of including more small and value stocks in a portfolio than a capitalization weighted index involves more risk.
If risk is measured by volatility, yes, a small and value portfolio will have more volatility. Volatility however can be useful in stock investing with a rebalancing plan and a longer time horizon.
Going back to 1927, I compared rolling monthly time periods of a small and value market tilt to US equities using the Dimensional US Adjusted Market Value Index against the S&P 500. Over shorter time horizons it was true that a small-value tilt will have higher highs and lower-lows.
The same is true of a 10 year horizon, though the difference between a best or worst period between the two indexes begins to become less pronounced. Since stock investing is often recommended for periods of 7+ years at a minimum (and I would suggest 10+ years if there is a shorter draw down period such as for college savings), it appears that the trade-off between the
The average outperformance of most average annual rolling time periods of the Dimensional US Adjusted Market Value Index was in the 2.5-2.6% range. However, longer-term investors experienced less of a ‘worst case’ scenario over longer periods.
With periods of 10, 15, and 20 year data to review the benefits of including small and value tilts to your investments becomes clear, and since most stock investment should be of a 10+ year time horizon, it follows that most investors would not be taking on ‘more risk’ by including more volatile stocks, but may inadvertently be subjecting themselves to a lower portfolio end result. Over a 20 year time horizon the Dimensional index outperformed the S&P 500 by 1.81% in the best time period and 2.21% in the worst period.
It pays to diversify beyond the S&P 500.
