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In Stock Investing, Size Matters
by Paul A. Merriman Publisher and Editor
Since 1994, large-cap stocks have outperformed small-cap ones. The two largest mutual funds are a Standard & Poor's 500 Index fund and Fidelity Magellan, both of which are dominated by stocks of large companies.
From 1994 through 2000, the largest U.S. stocks more than tripled in value. And the S&P 500 Index nearly tripled. In the same seven years, the smallest 10 percent of U.S. stocks appreciated only about 80 percent. See Figure 1.
(These charts, reprinted with permission from Dimensional Fund Advisors, are numbered in reverse chronological order. Thus Figure 1 is the most recent and Figure 6 is the oldest. To understand the numbers at the bottom of each chart, imagine that you ranked all U.S. stocks by market capitalization, then divided them into 10 equal groups. Each group would represent a "decile" or one-tenth of the whole. In the chart, each bar represents a decile, with "1" being the largest 10 percent of companies and "10" being the smallest 10 percent of companies.)
Today’s investors may think the S&P 500 Index has always been the standard to beat. But as you can graphically see in Figure 2, this is only a recent phenomenon. In 1991 through 1993, the largest 10 percent of stocks, based on their market cap (Decile 1), did only a third as well as the smallest 10 percent (Decile 10).
In 1993, everyone knew the best place to be was in small-cap stocks, which had finally come back into their own. In 1994, you could have looked at Figure 2 and "known" that small-cap investing was the place for your money.
Now let’s go back one step farther in time. You will see in Figure 3 that small-cap stocks treated investors like dirt from 1984 through 1990, falling more than 20 percent while stocks in the top two deciles – and the S&P 500 Index – rose about 150 percent.
See the pattern yet? Over any period of several years or more, small-cap stocks and large-cap stocks go sharply in and out of favor among investors. Rarely have both been extremely productive (or extremely unproductive) at the same time.
In Figure 4, Figure 5 and Figure 6 you will see three more time spans, in reverse chronological order, going back to 1965. Each one shows a reversal of the previous pattern.
Look at these starting with the period from 1965 through 1968 (Figure 6). Small-cap stocks more than quadrupled in value while the S&P 500 Index gained about 40 percent.
But then from 1969 through 1974 (Figure 5), all sizes of U.S. stocks lost money. And the small-cap issues, Deciles 9 and 10, fell by 70 percent. Ouch! By early 1975, it was obvious that the stock market was a dangerous place to park your money – and small-cap stocks were widely regarded as a fool’s game.
But from 1975 through 1983 (Figure 4), large-cap stocks nearly quadrupled. And the "fools" who had enough guts to invest in small-cap stocks (and who hung onto them) made out like bandits, with returns over 1,000 percent.
However, starting in 1984, the fortunes of small-cap investors turned sour once again, as Figure 2 shows quite dramatically.
So what’s an investor to do? As always, history gives investors lessons but not instructions. Here are some lessons that U.S. stock investors can learn from these six charts.
How can investors take advantage of this? Here are some ways.
If you have a strong stomach and a long-term perspective, consider rebalancing your small-cap and large-cap stocks every year. When you have gains from large-cap stocks, for instance, invest them in small-cap stocks the following year – and vice versa. If the reversals that are shown in these charts continue, eventually you will be rewarded by following this rebalancing, which forces you to automatically follow that most basic rule of investing: Buy low, sell high. And that leads to an important point that is sometimes ignored: Price matters.
Source: http://www.fundadvice.com
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