Seeking Alpha

Small Portfolio Changes Don't Matter

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Includes: BND, DJP, GLD, IJR, VNQ, VTI, VTV, VXUS, VYM
by: Movement Capital
Summary

More funds don't equal more diversification.

A portfolio should be analyzed for what it truly is under the hood - not what it looks like on the surface.

Small portfolio changes don't matter.

The investment product landscape is like the supplement industry. Supplement companies don't make money if you sleep eight hours a night, only drink water, and avoid junk food. Fund providers don't make money if you stick to low-cost index funds. We're inundated with products promising an edge, either for our health or finances. In investing, these products are typically marketed as satellite allocations to complement a core portfolio.

This post examines the total portfolio impact of small allocations. All hypothetical portfolios shown are annually rebalanced and include reinvested dividends and interest. I used Portfolio Visualizer for all of the below analysis.

Smart Beta

Smart beta funds imply that a portfolio advantage is one mouse-click away. Investors have bought into the marketing - Vanguard's Value ETF (VTV) has $45 billion in assets. Like a placebo, owning VTV only feels like you're doing something since the fund's performance has been a mirror image of the broad U.S. stock market. Other smart beta products like low volatility and quality stock funds have attracted billions in inflows. Some of these funds are closet indexers like VTV, but some are truly different and provide concentrated exposure.

Since smart beta funds are typically implemented as satellite allocations, investors should care if these small tilts actually impact portfolio performance. The table and graph below show two portfolios. One has half of its 60% stock exposure in smart beta funds. The other is a 60/40 portfolio with 60% in Vanguard's total market-cap stock fund (VTI) and 40% in Vanguard's aggregate bond fund (BND).

Portfolio comparison of a smart beta portfolio and a Vanguard portfolio

Portfolio impact of a smart beta tilt

Gold

Gold (GLD) (and commodities (DJP) in general) is popular with investors concerned over inflation or political risk. I'm not trying to debate the investment merit of gold. What I do take issue with is the common prescription of a small allocation like 5%.

Portfolio comparison between a portfolio with 5% in gold and a regular Vanguard portfolio

Portfolio impact of a 5% gold tilt

REITs

Real estate investment trusts (VNQ) tout stock-like returns, high dividends, and low correlation to stocks. Let's say an investor carved out 10% of their equity exposure and allocated it to REITs. Would it have made a difference over the past decade?

Portfolio comparison of REIT exposure and a Vanguard portfolio

Portfolio impact of a 10% tilt to REITs

Stock Slice-and-Dice

Slice-and-dice portfolios try to outperform the broad market by overweighting market segments that have historically outperformed. Let's say an investor decided to overweight small-cap (IJR), dividend (VYM), and value (VTV) stocks. Has this made a difference compared to a 50/50 split between Vanguard's total market-cap domestic (VTI) and international (VXUS) funds?

Portfolio comparison between stock exposure with many funds and a simplified Vanguard portfolio

Portfolio impact of tilting to small-cap, dividend, and value stocks

Ultimate Slice-and-Dice

This final scenario splits stock, bond, REIT, and gold exposure across fifteen funds. A lot is going on under the hood - but have the returns been different than a simpler (and lower fee) solution?

Portfolio comparison between a complex portfolio and a three-fund Vanguard portfolio

Portfolio impact of tilting to small-cap, dividend, value, bond funds, REITs, and gold compared to a three-fund Vanguard portfolio

Summary

There are two takeaways of the above data:

  • Small portfolio changes don't matter. Investors should either go all-in with substantially different allocations or simplify their portfolios.
  • More funds don't equal more diversification. Seeing 20 funds on a statement might make an investor feel more diversified, but, ultimately, it just creates unnecessary complexity.

Disclosure: I am/we are long VTI,VXUS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: All compound returns graphs include dividend and interest reinvestment and reflect fund expense ratios. All results are gross of transactions costs. Results shown are hypothetical, simulated, and are not an indicator of future results. All analysis was performed with Portfolio Visualizer: www.portfoliovisualizer.com/...

Movement Capital (MVMT Capital LLC) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where Movement Capital is properly licensed or exempt from licensure. This article is solely for informational purposes. Investments involve risk and are not guaranteed. No advice may be rendered by Movement Capital unless a client agreement is in place.