slice and dice vs. efficient market hypothesis

[Silhan]

I'm still a couple of decades away from retiring, and I have been maintaining a slice-and-dice allocation for the past several years.

However, I've begun to have some doubts about this stategy. If the efficient market hypothesis is valid--that is, if the market efficiently determines the relative prices of publicly traded equities--then why not hold only total-market index funds?

In my case, I'm currently holding U.S. large cap, U.S. large value, U.S. small cap, U.S. small value, REIT's, and energy. I'm thinking of replacing these with total U.S. stock market. Similarly, in international stocks, I'm holding Europe, Pacific, emerging markets, small cap, and value. I would replace these with total international stock market.

I realize that with this new portfolio I would not have done as well over the past several years. But who knows what the future will bring? It seems both simpler and less risky to hold only total-market index funds instead of trying to guess which subsets of the market should be overweighted.

What do you think?

 

[LOL!]

If it ain't broke, don't fix it.

I'm reading Rick Ferri's All About Asset Allocation and I have read the articles at Paul Merriman's www.fundadvice.com site. I have to say, the arguments are compelling for slice-and-dice.

You might also wish to read this thread over at the Diehards forum:
Bogleheads :: View topic - Poll: What's your asset allocation philosophy? where more than 2/3rds of respondents use slice-dice and give advice.

 

[kcowan]

We have just 5 funds in our retirement account for much the reasons you gave. We do hold individual stocks in our investment account but with some attention to overall asset allocation.

 

[unclemick]

Hmmm

Always the sucker for the new thing - Jan 2006 Vanguard Target Retirement 2015 for my tax deferred retirement after dinking around the edges of my big dog 60/40ish Lifestrategy for ten yrs with 10% REIT and a tiny dab of Sm Cap Value and my DRIP plan dividend stocks.

heh heh heh - Catch ya back in another ten years and we'll see how I 'done did'.

P.S. I still cheat - at 63/64 so my 2015 pick is an optimistic young at heart instead of Vanguard's older recommendation for my age.

 

[Nords]

However, I've begun to have some doubts about this stategy. If the efficient market hypothesis is valid--that is, if the market efficiently determines the relative prices of publicly traded equities--then why not hold only total-market index funds?
It seems both simpler and less risky to hold only total-market index funds instead of trying to guess which subsets of the market should be overweighted.
What do you think?

If the efficient market hypothesis was really provable, wouldn't it have advanced to at least "theory" or even "axiom" by now? The reason that it's still the EMH is because it doesn't account for investor psychology and the market's occasional lack of liquidity. It assumes that bell curves follow mathematically-treatable distributions instead of their actual fat tails. As long as Taleb is finding black swans (and Buffett is buying them) the markets will be inefficient.

In their study of a century's data over 16 countries, Dimson & Marsh's "Triumph of the Optimists" validated the existence of the value premium. Everyone is still squabbling over its cause, but it still exists. That's good enough for my purposes.

I also remember reading somewhere that the collective returns of the S&P500, S&P Midcap 400, and S&P Smallcap 600 indexes exceeded the returns of the S&P1500 index. I don't recall any of the study's methods or their validity and admittedly they're messing with the composition of all four of the indices, but the fact that three subsets outperformed the union lends a lot of credence to slice & dice.

I think the only advantage to going total market indexes is a lot less paperwork. But that could be a very significant advantage!

 

[Rich_by_the_Bay]

I've moved from moderate slice-and-dice to Bogle's "own the market" approach myself. I add international at 20% and still have a little boost of small market index, but I'll probably fold that back in to VTSMX, too.

It works for me because I don't intend to touch it for a long time (like 14 years) and I'll infrequently rebalance against international only.

Another benefit is that it was psychologically liberating not to have to worry about beating or losing to the market. Long term not that many will beat the total market with active management, so I'm real comfortable with it.

 

[Olav23]

No one is going to be able to validate it, except in retrospect. You could certainly be right that the value premium exists, and it takes over your lifetime to show itself. Were you still correct? Was it worth it?

I like having smaller pieces to tinker with, and the fun of rebalancing between different components. If I was less interested, I might go target retirement.

You have to decide what you enjoy spending your time doing, and have at it. We'll let you know if you made the right decision on your deathbed

 

[ESRBob]

One other thing to consider: slice and dice is designed to generate a blended portfolio that has the reward and risk characteristics you are seeking. In other words, just owning the market would earn you more, but with greater volatility.

Semi-retirees/FIREes generally are willing to trade off some of that upside in order to have a smoother ride - i.e. lower volatility which allows greater portfolio survival against in the face of regular withdrawals in up and down markets.

That is what slice and dice has historically provided.

I still think there is a value premium, but don't exactly know why. Even if it means we are taking on more risk and thus only earning the extra reward for risk taken, the fact that the returns of value, small or international stocks are less correlated with returns of the Total Market means overweighting them can generate a less volatile portfolio. That's what we're after.

EMH only tells you whether the prices of the securities are fair for the risk undertaken. Slice and dice is about designing a portfolio that does useful things for you over time.

 

[audreyh1]

I don't believe in the "efficient market hypothesis" simply because I have seen too often with my own eyes times where certain asset classes become wildly over- or under-valued due to some external market or political event that can quickly correct. Often things get blown out of proportion on the over or underside. That's not very efficient IMO. That's why asset allocation works for me.

Markets are SPECULATING - they aren't KNOWING. When the herd guesses wrong (and they often do), they eventually correct. It can take a long time. Oh yeah - and the guesses keep changing all the time too.

Asset allocation is the best way I know to do good contrarian betting.

Audrey

 

[Rich_by_the_Bay]

All good points. I think it's a philosophical issue at heart.

I really don't want to beat the market at this stage. Nor do I want to trail the market. I just want to match it (after minimal expenses). My risk / volatility tolerance is adjustable not by the asset allocation within my stock portfolio (total market), but rather how much I put in the total stock market v. fixed income. Bogle's "Little Book of Common Sense Investing" says it much better than I could. I resonated with his reasoning and references.

I'm beginning to look at volatility as a function of how closely your returns matched the total market rather than how much their absolute value rose or fell (realizing that's not the traditional use of the term).

 

[Spanky]

Here is an good article in support of S&D over total market.
Index Funds Advisors - ifa.com - Articles

 

[Olav23]

Here is an good article in support of S&D over total market.
Index Funds Advisors - ifa.com - Articles

Remember, though, the source is a fee-based financial planner! Obviously it is in their best effort to steer you into as much activity as possible.

This is not to say the article isn't relevant or insightful, just that you should understand the source of the information.

Interesting quote from wikipedia:

EMH is commonly rejected by the general public due to a misconception concerning its meaning. Many believe that EMH says that a security's price is a correct representation of the value of that business, as calculated by what the business's future returns will actually be. In other words, they believe that EMH says a stock's price correctly predicts the underlying company's future results. Since stock prices clearly do not reflect company future results in many cases, many people reject EMH as clearly wrong.
However, EMH makes no such statement. Rather, it says that a stock's price represents an aggregation of the probabilities of all future outcomes for the company, based on the best information available at the time. Whether that information turns out to have been correct is not something required by EMH. Put another way, EMH does not require a stock's price to reflect a company's future performance, just the best possible estimate of that performance that can be made with publicly available information. That estimate may still be grossly wrong without violating EMH.

 

[mickeyd]

I've been scoping many boards for about 4-5 years and I think that S&D is defined differently by most of us.

Is anything more than one MMF, one US equity fund (TSM?), one international fund (TI idx?) and one bond fund (TBM?) what we call S&D? I think so.

I don't give one flip if I am considered a S&Der or not, but I pretty-much have eight funds that I am invested in and that gives me the perfect diversification and AA that I require in my little portfolio stash.

 

[Spanky]

"Sliced and diced" means that sliced and diced by market cap, style, industry, regions, etc.