Total Market Stocks vs. Diverse Mix

Discussion of the Stock portion of the Permanent Portfolio

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Sam Brazil
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Re: Total Market Stocks vs. Diverse Mix

Post by Sam Brazil » Wed Aug 12, 2015 11:57 am

I'm a fan of RSP equal weight SP500. It has outperformed SPY handily over the past decade or so but comes with a .4% expense ratio (not that I think out performance over X period is a good measure of what's better).

From all the research I've done, it seems smart people cannot agree on whether it's worth the extra expense or whether its out performance is simply extra beta, a relalancing bonus or something else.

IMO, it's probably a situation where in the future it will under perform or over perform the SPY over short periods, but you have to make a bet about whether it will outperform on a risk adjusted basis over the long term. Personally I'm sticking with it because:

1) Investing in a cap weighted index that is dominated by a small fraction of constituents is counter the purpose of indexing and diversification and amounts to a mega cap momentum strategy...I'd rather go with true diversification even if I can't guarantee it won't outperform mega cap momentum during all periods in the future. To put it in even more concrete terms, why would I want to place a bit bet on Apple?

2) The increased volatility of RSP vs. SPY is good in the context of the PP because TLT and GLD tend to have higher volatility anyway, so its a nice counter balance.

3) I'm betting there's a good chance a lower priced competitor to RSP will emerge, reducing the impact of the expense ratio over the long term.

4) When you think about it, choosing to cap weight and rebalance X times per year as in SPY is not a magic naturalistic set of rules handed down by the Gods...it's just a set of rules humans came up with, and I don't think there should be the presumption that that set of rules is superior to any other set of rules, especially when the other set of rules is more diversified and market cap neutral.

5) The other extended market ETFs I've seen beyond SPY also suffer from the same overweight problem in the largest caps, so they aren't a good alternative answer vs. RSP.

6) I personally sleep better at night knowing I'm really diversified vs. making a big bet on Apple, Google and handful of other mega caps and if that helps me stick to the plan then it's probably worth the extra expense because panic selling is the worst of all options.

Check out boglehead threads for some great research into the issue. I'd be curious what others here conclude.
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ozzy
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Re: Total Market Stocks vs. Diverse Mix

Post by ozzy » Wed Aug 12, 2015 1:10 pm

Sam,

I totally agree with all your points.  My own research shows much better performance and diversification with the inclusion of Small/Midcaps.  But the expense ratio on RSP is a whopping 0.40%!  Yikes!

Why not use individual Small/Midcap ETFs instead?  For example, replace RSP with IJR, IJH, VTI, all are high-quality funds with very low expenses.  I realize adding 2 more ETFs increases the complexity slightly, but you're only rebalancing yearly, so it's hardly anything.

Also, you can use Morningstar's Instant X-Ray (free tool) to determine a portfolio's detailed breakdown (including cap-weighting).  This allows you to configure a portfolio with the exact weighing you desire.  Check it out:  http://portfolio.morningstar.com/Rtport ... Entry.aspx
Sam Brazil
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Re: Total Market Stocks vs. Diverse Mix

Post by Sam Brazil » Wed Aug 12, 2015 9:38 pm

ozzy wrote: Sam,

I totally agree with all your points.  My own research shows much better performance and diversification with the inclusion of Small/Midcaps.  But the expense ratio on RSP is a whopping 0.40%!  Yikes!
I rationalize it because of reasons #5 and 6 above mostly, but truth be told, I'm not sure it's rational to be paying that much expense ratio...I have personal deep seated biases against a few of the top companies in the S&P 500 cap weighted (like Apple) and I know myself...if those stocks start to crash there's just too much risk I'll panic sell. So it makes sense for me to pay for the peace of mind of RSP, but not sure about for others.
Sam Brazil
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Re: Total Market Stocks vs. Diverse Mix

Post by Sam Brazil » Thu Aug 13, 2015 11:22 am

After doing some more research, it seems EQAL may be the better choice than RSP because it's a .2% expense vs .4%...still worse than SPY but a big improvement.
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