This page uses historical returns to suggest some simple long-term, buy-and-hold allocation guidelines.
The indexes used are the Fama and French research portfolios, which go way back to the 1920s.
The bad news is that these indexes use a non-standard splitting of the market which is not currently available in any low-fee index funds.
We'll get back to that problem at the bottom of the page; for now, here is a calculator that shows how well the different index styles have been doing.
Two big trends:
- The Total Stock Market has been returning about six or seven percent annually, after inflation;
- Small beats Large, and Value beats Growth.
The Small Value advantage has been a long-term phenomenon that hasn't held consistently over shorter periods;
in particular, small stocks did poorly between the mid-1980s through the 1990s.
(See Stocks for the Long Run for much more about that.)
That's why an extreme weighting toward any "corner" of the market isn't such a good idea - fifteen years is a long time to be wrong - and why the next point is really "the" point:
- Adding some Small Value to a Total Stock Market portfolio can give higher returns, and not much more volatility, than you would get with the TSM alone.
This suggests an obvious approach to building a halfway decent stock portfolio:
put most of your funds into a Total Stock Market index, with a small amount (preferably within a tax-sheltered account like a Roth IRA) in Small Value.
Making it Real
So far we have been looking at data from the academic Fama and French indexes;
so here is a summary of the popular "real world" Small Value indexes that actually have low-fee index funds and ETFs tracking them:
|Small Value Index
|S&P 600 / Barra Value
||Simplest value/growth methodology,
based on price/book only
|Russell 2000 Value
||Simplest "size" methodology;
contains more of the smallest companies
|MSCI U.S. 1750 Value
||Vanguard likes it
(but it's less "small" than the others)
|Morningstar Small Value
tends to have low P/E ratio
This means that the very best index must be ... your own judgment call.
Seriously, the future is going to bring so many economic surprises that trying to pick the optimal index methodology feels demented.
It's probably more sensible to stick with a fund that charges low fees and has a reputation for respecting its investors, and then thinking in terms of very broad allocation guidelines (like "mostly TSM, plus some Small Value").
(See the separate small value article for more.)