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william0509 (98.89)

Small Caps Fund for IRAs, or Long Term Investment?

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May 13, 2009 – Comments (1) | RELATED TICKERS: VB

          I was being told by one of my friends that small caps can yield 8% return on average after inflation adjustment, according to his findings.  He put almost all of his money on Vanguard Small-Caps Value Index Fund (VISVX), and believed that he would get the expected return on his investment and live rich in his retirement years (he was definitely considered as a defensive investor to me according to Benjamin Graham's classification on investors ).   I had never questioned that Small Caps will outperform the major indexes (i.e. Dow Jones Industrial Index) in the long run.  But, I highly doubt that he will get the average 8% return through the rest of 30 years by just purchasing the Vanguard Small-Caps Value Fund. Since he started to invest in 2007, I believe that wrong timing and one's lifespan have strong effects on his future return, which he did not take into accounts and went for the historical statisitics.  As a follower of value investing,  I strongly believe that the past performance can't guarantee the future.  After carefully examined the portfoilo in the Vanguard Small-Cap Value Fund, the fundamentals of Vanguard Small-Cap Value Fund are mediocre and intermingled good and bad stocks.  It spreads too much on financial sector (which is characterized by its high debt-to-equity ratio), which was hardly hit by the financial crisis during this downturn economy.  Investors can be better off by cherrypicking stocks from the Small-cap Value Index with valid analysis than simply invest in index fund.  (Fools, please feel free to express opinions on this topic, so we can all learn something from each other.)

1 Comments – Post Your Own

#1) On May 13, 2009 at 9:17 PM, russiangambit (99.18) wrote:

I would say, your frind needs to have a back up plan for the retirement. Even when we recover, the expectation is to have a low growth for a very very long time, like 10 years, which means stocks will probably return 5% or so, and even that might be too optimisitc. 

General wisdom is that small caps , i.e. Russel, outperform in the bull market, especially in early stages (when the most beaten up stocks rise the most), and underperform in bear market due to small companies having hard time accessing capital.

Of  course, make up of the fund makes a big difference. However,  I am not at all certain you can successfully cherry pick small cap companies, since there is very limited information on them and they have little track record. So, I would personally go with the index. 

Then I also have a probelm with mutual funds , which stay almost fully vested during down markets. We are now closer to the bottom than in 2007, so may be it is OK to start investing now for long term, even if there is a potential for 20-30% downside still and the mutual fund will not protect you from it. If I had to choose to hold mutual fund or  cash, I would hold cash until SP500 crosses MA200. That is a confirmation that bull market started, However, by then Russel outperformance will already wane and you might as well stick with SP500.

Confused yet? There is no good answer to your question, unfortunately. There are too many moving parts in the market.

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