Do you net out investment expenses from your SWR?

[ESRBob]

Here's a link to the cumulative weightings on the S&P 500.
http://www.indexarb.com/indexComponentWtsSP500.html

As long as you know what you're getting, its fine. I want to be widely diversified, and for me that has meant stepping outside of simply matching the cap weighted market. I don't want to tie my fortunes so closely to 50 firms or worse, the top 15 firms which make up 30% of the index.

After all, we are seeking less-correlated or non-correlated asset classes, and the SP500is inherently yahnked around by the fortunes of those 15 or 50 companies, which often tend to move in lockstep with the fortunes of the overall economy. I do hold a bit of the SP 500 index for convenience, but my large cap stuff is loaded up with Value Index (and yes, I admit it, I have some of Vanguard's Primecap leftover from my earlier unenlightened pre-index days). But for stocks overall, we are very heavily loaded up with small cap (again with a value tilt)-- they have good long term performance and are low-correlation to the big stocks and just about everything else. (albeit with high volatility).

I am struggling to try to express this concept, and I know that lots of smart people are lined up against me on this one -- S&P 500 is the supposed god of prudent diversification, but I am just feeling strongly like there is a better way to diversify, perhaps at marginally higher cost, but with much better long run performance. Can anybody help me out here? I'm not even sure how to do a study to shed light on this, but I'm thinking it is important.

[charlie]

ESRBob,

I compared the S&P500 Index to the equity part
of the "coffeehouse" portfolio, which is composed
of equal weightings of S&P500, Large Cap Value,
Small Cap Value, Small Cap Index, Total International
and REIT Index for the 20 year period from 1984
through 2003. The REIT Index was only included
from 1997 through 2003. The results were:

S&P500: Total annualized return = 12.78%, with
sigma = 16.65%

Coffeehouse : Total annualized return = 12.26% with
sigma = 14.61%

The most interesting thing I discovered was that
the Coffeehouse had returns of 4.50%, -2.48%,
and -14.77% vs. S&P500 with -9.06%, -12.02% and
-22.15% in 2000, 2001 and 2002 respectively.
The REIT Index, Small Cap Index and Small Cap
Value really helped in that time period.

What I took away from this is that diversification
truly helps dampen volatility even if long term
returns for each asset class are very similar.

Cheers,

Charlie

[BigMoneyJim]

Quote:

I wasn't making any claim as to whether the SP500 was overvalued or undervalued itself, now. I am objecting to the index itself as giving a false sense of diversification -- you think you are buying 500 stocks, but in reality, (I will check the figs for a followup post) since it is a cap-weighted index, you are getting a huge proportion of your SP500 investment in a few dozen companies, and almost nothing in the bottom300 or 400 stocks.

Okay, that's a good point, and one I had forgotten. I'll roll that around in my head for a while and see what comes out.

Quote:

Then, BMJ, you 'outed' me on another bias, though, which is growth vs value. I've been reading enough stuff by the DFA and Chicago crowd, (Fama/French) to make me think that at a minimum a value 'tilt' is a big advantage in virtually any stock portfolio (they reckon some sort of persisting value premium of 2-3% per year in small, large, international, domestic --anything) Growth stocks just seem to make lousy investments. Near as I can explain it to myself, if everybody loves a company, then its stock is bid up. If everybody knows a company sucks, then its stock is beat up. You may want to buy the growth company's products, but the slightest hiccup will trash its stock. Avoid the value company's products perhaps, but if you have a diversified batch of their stocks (obviously any single stock can go bankrupt, they are bid down for a reason!) then the stocks will eventually come around, and statistically much better than growth stocks in performance. Just not falling off a cliff means their prices will tend to get bid up when people forget they are basket cases.

My intuition--or perhaps my 2000 experience--has me wary of growth stocks, too. I don't have a strong opinion--just a feeling. . . .

Sorry, this post got interrupted by some phone calls a couple of hours ago and I have long since lost my train of thought. I will give some more thought about the weighting of S&P 500 and TSM (I'm assuming your objections to S&P 500 apply almost as well to TSM) growth stocks versus value stocks and plausible (for me) alternatives.

[wabmester]

Quote:

S&P 500 is the supposed god of prudent diversification, but I am just feeling strongly like there is a better way to diversify, perhaps at marginally higher cost, but with much better long run performance.

Who made the S&P 500 god? It's more like the model-T of indices. If you want true diversity, own the entire market. If you believe the market is efficient, then own the entire market using cap weighting. I think the best you can do from a diversity and cost standpoint is 50% Vanguard Total Stock Market + 50% Vanguard Total International Stock Market.

Adding a "value tilt" is similar to buying a junk bond fund. You get a risk premium, but you also get high volatility. You mitigate risk by buying lots of junk and hoping that some of it becomes quality. A perfectly reasonable strategy.

[cute fuzzy bunny]

OOOh Wabmester, I disagree.

Owning a broad collection of value stocks, either hand picked, in a manged fund specializing in value stocks, or in a broad index does NOT appear to me to induce more volatility as a rule.

In fact, in times of overvaluation like these, there is some comfort in owning a collection of stocks with price to earnings ratios in the single and low double digit range.

To be fair, owning a few value stocks can create tremendous volatility. If you have a fund or a collection of 50 or more well chosen issues, I think you have little to worry about.

However, I've yet to see any analysis of value stocks that measured longer then 3 years that didnt put value well ahead of growth or blends. Heck, Bernstein devoted an entire section of the four pillars to the curious aspect of crappy companies producing consistently superior results...

[unclemick]

Yep - Bernstein has visited what he calls 'the value premium' more than once over the years and has admitted on occasion the limits of his math/stat ability to explain it to his own satisfaction - yet (he has faith he'll get it).

Ben Graham - in a glancing blow said that the market values dividends more 'highly' than other valuations/methods in value stocks - the bird in hand school of thought.

[wabmester]

Quote:

OOOh Wabmester, I disagree.

Blow me *

Quote:

Owning a broad collection of value stocks, either hand picked, in a manged fund specializing in value stocks, or in a broad index does NOT appear to me to induce more volatility as a rule.

You're sort of right. * At least when the economy is strong. *When things go bad, junk/value is the first to feel the hit.

I'll let our hero Swedroe explain it:

http://www.etfzone.com/articles/2002..._adv_md_LS.php

Quote:

In fact, in times of overvaluation like these, there is some comfort in owning a collection of stocks with price to earnings ratios in the single and low double digit range.

As long as you understand why the P/E is low. * The market is telling you these companies are risky and might fail. * The low P/Es of value stocks are pretty much a direct analog to the high yields of junk bonds. *Holding individual issues is risky, but holding a basket will generally provide good returns. * The volatility of individual issues generally tends to be out of phase with one another, so as you learned in physics, that will lower the amplitude. * You need to watch out when the volatility is in phase, such as economic downturns, which will increase the risk amplitude, dude.

[BigMoneyJim]

Quote:

Blow me

I wonder if this will catch on like the dryer sheet thing....

I won't make flags this time, though.

Quote:

I wonder if this will catch on like the dryer sheet thing.... I won't make flags this time, though.

And I won't be changing my Moniker to Deep-Throat

[cute fuzzy bunny]

Hey, we could sell those flags for real money.

I want one in fact.

Junk bonds do get killed in poor economical situations, but isnt it true that in the recent bear markets value stocks did much better than growth or blend, at least in broader funds?

Maybe part of the reason that I own "junk" bonds
is empathy. There was a time when I had to
struggle to borrow what I needed. Now people
are throwing money at me. Anyway, I understand
junk bonds and am comfortable with a large part of
my portfolio being allocated there.

John Galt

[charlie]

Hey TH,

You should read the Swedroe link provided by
wab earlier. It's the straight poop!

Charlie

[cute fuzzy bunny]

Charlie...I have read it before and just did read it again.

Supports what I said...in the 73-74 bear market value stocks outdid growth, and in the recent 2000-2002 bear market, value thumped growth pretty good.

My feeling is that stuff that is already beaten up is a better place to be in a down time that stuff thats way over priced.

But I'm a weirdo.

[unclemick]

Heh,heh,heh Well TH

Being weird just might be better than the 215 orangutans - Appendix I, 4th ed, The Intelligent Investor Ben Graham. Warren Buffett's 1984 speech on value investing at Columbia. But then again the orangutans may have gone on to develop the fro-runner of the efficient market hypothesis and mordern portfolio theory - no post script on that.

Of course I have a bet on both camps - just in case the orangutans were on to something and Buffett was wrong. Heh, heh