Smallcaps: Where You Don't Want to Be at the End of a Cycle

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Includes: IJR, IWM, JKJ, SLY, SPY, VB
by: Roger Nusbaum

I had a small awakening of sorts yesterday. I stumbled across a message board on Motley Fool that is devoted to small cap stocks.

A couple posters lamented what sounded like huge declines from the peak (not sure if they meant the peak of their portfolio or the peak of the market). We are talking mid 20's for some of these folks. Yikes.

I have said many times that the combination of new products and time well spent would empower do-it-yourselfers to have a better chance at success.

After reading through this thread, I did not draw a favorable conclusion about the knowledge or skill level of the folks posting. The comments were not too specific on whether they all focused on small cap stocks (which was the theme of this particular board), stock picking or whatever.

Small caps, from the top down, is the wrong place to be at the end of the cycle. In the last three months iShares Russell 2000 (NYSEARCA:IWM) is down 16%. SPY is down about 10%. The guy who kicked things off on this thread said he is down 26% from his peak (which of course might be different than the market's peak) and says he is currently only 18% invested after his "systematic sales." So down 26% and 72% cash?

Yo, dude, something's gotta change, like now.

There were also a couple of walking in your footsteps comments too. Cheese O Pete. One thing that I think I glean from these posts is that these people do put in time working at it. I figure anyone who has systems, whatever that means, and takes the time to not only read Motley Fool but also post on a message board is probably putting in a lot of time. Despite my having written for TMF in 2004, I never got the sense that things like risk management or market cycles were a big priority there, but things may have changed since then.

So while my empowerment theory may not hold water, I still do believe that investing can be as simple or as complex as you want to make it. I am well aware that good bottoms up stock pickers can have success in any environment, but in case that is not you, and you are not paying some who can do that, you might want to try something else.

People seem to like to make investing more complicated than it needs to be. The message board I am referring to, and some of the comments left on this site, make that apparent. I am not trying to be insulting, I am hoping to convey that saving properly is more important than beating the market. Avoiding one or two things (here I mean underweighting) every so often can go a long way to less pain than in the broad market, during the occasional down swings that is. Remember the U.S. stock market has an up year about 3/4 of the time.

I say this a lot, but all of the top down stuff I write about regarding sectors, growth versus value, cap size and the like, is very elementary and requires no analytical skill whatsoever. Looking for a bunch of small cap stocks to own when history says small cap will lag, seems like a colossal up hill struggle. It's even worse for the people trying to do just that when they are the ones who don't know when small cap is likely to lag.

Lazy portfolios are right for many people for a reason: they get the job done. Whether they beat the market or not, they keep you close which is plenty for, intentional repeat, people who save properly. If you can actively manage your portfolio without blowing up much worse than the market, great. But know whether or not you can, and then pick the right strategy for your skill, temperament and time you can spend.

That was a bit of a rant, wasn't it?