By Paul A. Merriman|Mar. 29th, 2017
Regular readers: I’m rolling out some brand new recommendations for long-term investors.
For more than 25 years, I have been advocating wide diversification among U.S. and international stocks, including growth stocks and value stocks, large-cap stocks and small-cap stocks.
Long-term investors in the portfolio I describe as The Ultimate Buy and Hold Strategy have consistently (although not every individual year) outperformed the S&P 500 index SPX, -0.43% at reduced risk.
I believe thousands of do-it-yourself investors have directly benefited from this combination, which reflects the way that Merriman Wealth Management (with which I am no longer affiliated) still manages money for clients, including a major portion of my own portfolio.
The «something new» I’m introducing today — and most of the rest of this discussion — concerns only the equity side of the Ultimate Buy and Hold Strategy. (My recommendations for bond funds remain unchanged.)
Until now, I’ve recommended slightly overweighting this portfolio to value stocks, which as most savvy investors know have a reliable long-term record of doing better than growth stocks.
This overweighting occurs when your portfolio is made up of 50% in value funds and 50% in blend funds; the latter contain both growth stocks and value stocks. Hence, value stocks make up somewhat more than half the equity portfolio.
Until this year, I never asked myself what seems like an obvious question: What would the results be if we eliminated blend funds and went to an all-value portfolio?
When I posed this question, I expected the returns of an all-value approach to be greater, and they were. I expected the risks to be higher, and they were, but not as much as I had expected.
In short, I discovered that all-value is a way to get appreciably higher returns without taking on much more risk.
Here are some numbers: For the 47 years from 1970 through 2016, the all-value variation of my «ultimate» portfolio returned 12.1%, compared with 11% for the standard version that includes blend funds. Standard deviations: 15.1% for all-value, 14.7% when blend funds were included.
That is just as expected. A similar pattern holds for variations of these portfolios that include differing levels of bond funds — in other words 90% equity, 80% equity, 70% equity and so forth. You will see some of this in this table.
You may have seen this table before. If not, I promise it’s not as intimidating as it looks at first glance.
Each line in the main part of the table represents a single year. Column by column, you can see the returns of various stock-and-bond combinations. On the far right, for reference, you’ll find the return for the S&P 500.
Before we examine the table more, I want to address the issue of «risky» value stocks. As you probably know, a value stock is a company that for some reason is out of favor with institutional investors; hence its price is relatively low in relation to the company’s underlying book value.
This doesn’t necessarily mean a value company is «bad.» In fact, you will undoubtedly recognize some of the largest U.S. value companies.
At the end of 2016, the top 10 holdings of the Vanguard Value Index Fund VIVAX,-0.35% included Microsoft MSFT, -0.68% Johnson & Johnson JNJ, -0.06% Exxon Mobil XOM, -0.28% Warren Buffett’s Berkshire Hathaway BRK.B, -0.46% and General Electric GE, -0.03% That’s not what most people would think of as bad company to keep.
If you own value companies one by one, they can be riskier than more popular growth companies, although I have argued many times that owning any individual stock is unnecessarily risky.
But when you own value stocks by the hundreds or thousands using index funds, you mitigate this risk and can take advantage of value stocks as an asset class.
OK, now back to the table. If you want to follow my train of thinking, you might want to print it out. Otherwise follow it on your computer.
What I’d like you to do is use two fingers to scroll down the list of years and make three comparisons.
- First, the S&P 500 vs. the 100% all-value.
- Second, the S&P 500 vs. the 60% all-value.
- Third, the S&P 500 vs. the 40% all-value.
If you know the return you need, and you want the lowest-risk way to achieve it (at least based on nearly half a century of market history), this exercise should show you some interesting things.
The table measures risk statistically, using standard deviation. This is good for mathematicians, but I doubt that many people think about risk that way.
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Here’s another way: Actual losses. Nobody likes to have a calendar-year loss, right?
In the 47 years covered by this table, the S&P 500 had nine losing years, one of them a whopping 37%. Ouch! As noted above, the payoff was a compound return of 10.3%.
If you were satisfied with that return, over that same period, you could have invested in the 60% equity variation of the all-value portfolio. (That means 40% of your money was in bond funds, not exposed to any stock-market risk.)
That would have given you only six losing years, the worst of which was a loss of «only» 25.6%. And you would have achieved a 10% return.
That’s just one example of things you can learn if you scroll down other columns looking for combinations of losses and long-term returns.
The news here is better than it looks for all-value investors. Except for the S&P 500 index, the returns in the table were all calculated assuming a 1% annual management fee.
Without that fee, the returns in all these columns (except for the S&P 500) would be greater. In my latest podcast, I tell you how to invest in an all-value portfolio using low-cost ETFs and mutual funds.
What I most want is for you to consider adopting an all-value flavor for the equity part of your retirement portfolio.
For young investors who have lots of time to reap the rewards, all-value is clearly a great option.
Even for retirees, this is worth considering. Many retired investors have accounts that they don’t expect to need in their lifetimes. I believe they should consider taking more risk and essentially investing like a young person.
I’ve put some of my own money behind this belief. I have a Roth IRA that I expect will remain untouched until it eventually becomes part of my estate. I have now invested that account in an all-value portfolio.
That portfolio consists of five ETFs that together give me positions in about 5,800 stocks. Last year they had a return of 15.9% and would have returned 12.4% for the past 46 years.
Someday, I expect my kids will be glad I have done this.
For more, check out my podcast called «2017 Update: Fine-Tuning Your Asset Allocation.» In it, I compare more details of the all-value portfolio with the Worldwide Equity Portfolio (the all-equity version of the Ultimate Buy and Hold Portfolio) and an all-S&P 500 Index portfolio.
You’ll find the tables here.
Richard Buck contributed to this article.
