Value Vs Growth - Investment Advisers: Sarah & Ujae

Summary

• We often come across those who believe that if you have S&P 500 index fund and an aggregate bond fund, you are diversified.
• We think a diversified portfolio should at least include real estate investment trusts and small/mid-size company stocks.
• Those who believe S&P 500 index fund is the best and only way to invest are missing out on important historical facts.

Value vs Growth - Investment advisers: Sarah & Ujae

We often come across those who believe that if you have S&P 500 index fund and an aggregate bond fund, you are diversified. Lately, adding aggregate international fund is suggested to make a simple diversified portfolio more sophisticated. We agree that it would be better than a handful of stock picks.

The phrase, “diversified portfolio,” is not clearly defined and differs significantly depending on who you talk to.

We think a diversified portfolio should at least include real estate investment trusts and small/mid-size company stocks. When you invest only in the S&P 500, you will be missing out these asset classes. Between 1997 and 2016 (20 years),

• Small/mid-size companies returned on average 9.46% annually.
• Real estate investment trusts returned on average 9.13% annually.
• Large cap value companies returned on average 8.33% annually.
• Large cap growth companies returned on average 6.88% annually (the majority of these stocks determine the S&P 500 index return these days)

Also, a diversified portfolio should include value stocks, which are often ignored when going only with index funds. Growth stocks are the high-flying stocks that command sky high valuations with a lot of future promises, such as Google, Amazon, Facebook types of stocks. However, value stocks are made up of mainly old companies that have proven cash flows, such as Johnson & Johnson, Berkshire Hathaway, etc. The stock market is getting too much influence from growth stocks these days. In 2000, at the beginning of the tech bubble burst (beginning of recession), growth stocks lost 22% while value stocks gained 7%.

Those who believe S&P 500 index fund is the best and only way to invest are missing out on important historical facts. Unfortunately, large cap growth (i.e., S&P 500) does exceptionally well right before a major crash. Why? When new or inexperienced stock investors want to invest, they go for the familiar and hot stocks, which are mostly from large cap growth asset classes. Over the past 3 years or so, large cap growth has had a lot of growth. However, because of deep drops in each correction, large cap growth (i.e., S&P 500) does not outperform small or value company stocks in the long run as shown in the table above. If you look at the table below, the red color denotes value stocks underperforming growth stocks in each of the company size categories. In 1999, value stocks significantly underperformed. However right after the stock market crash in 2000 values outperformed growth. Same story in 2007, right before the big stock market crash, values underperformed significantly. Now we are seeing Deja-vu in 2020.

Does that mean you have to duck to cash? No! It just means you should be more cautious and become a studious risk manager. That is really all you can do, because you never know when the stock market will bring you up or down. We just think the probability of downside is heighted.

Sarah & Ujae Kang

UAK Diversified Wealth Management.