It must be something in the air: A lot of investors right now are looking more closely at their asset allocations and wondering whether they need to adjust their portfolios. For example, one letter in the Motley Fool Answers mailbag this month is from a millennial listener who wants advice about the right balance among large-cap, mid-cap, and small-cap stocks for his retirement portfolio -- and also for the portfolio of his mother-in-law, who has a much shorter time horizon before she'll need to start drawing down on her assets.
In this segment from the podcast, hosts Alison Southwick and Robert Brokamp consider the problem with the help of special guest Buck Hartzell, director of investor learning and operations at The Motley Fool.
A full transcript follows the video.
This video was recorded on Oct. 30, 2018.
Alison Southwick: The first question is from Alexander. "I'm 27 years old and hoping to retire somewhere between 65 and 67. How can I decide the right mix between large, mid, and small-cap equities? From what I see on the web, small caps have performed the best. Since I have many years until retirement, it seems to me that I can afford to take the risk and have more of my money in small caps. Yet, advisors and the resources I found online shy away from having a large percentage in small-cap companies. Also, my mother-in-law is about 11 years from being 67 and retiring. What's a smart mix for her?"
Robert Brokamp: Well, Alexander, let's start with the outperformance of small-cap stocks. Those numbers often come from Ibbotson, which has numbers from 1926 to 2017. Over that period, small-cap stocks returned about 12.1% compared to large-cap stocks, which are 10.2%. So about a 2% difference.
The studies that found these, though, even though those numbers go back to the 1920s; it wasn't really until the 1970s that people began to pick up on this. Then small-cap investing became popular and then from like the early 1980s to the late 1990s small caps significantly underperformed large-cap stocks.
In fact, some people like Jeremy Siegel think that there is no outperformance of small-cap stocks. It's due to a couple of periods like the 1970s when small caps did particularly well. Not everyone agrees with that. If you look over the last, say, 15 years small caps have outperformed, but over the last five years, large caps have outperformed.
The main point is that we don't really know what the future will look like. For someone like you, I think it just makes sense to have an equal allocation to large, midcaps, and small caps, because we don't know what the future is going to look like.
One issue is that the smaller you get, the more volatile the stocks do become but because you're young, that's OK. If you're talking about [I think you said it was your mother-in-law], I think it makes more sense to lean toward large-cap stocks. They're less volatile, but more of those companies are more likely to be paying dividends, which I think makes sense. Dividend-paying stocks generally tend to be less volatile, but also once you're retired, it's nice to get that income.
Buck Hartzell: And I would just say for anybody looking at small caps -- I don't know if we define that all the time for folks -- generally we look at stocks under $2 billion market cap and then things above $10 billion are generally large-cap stocks.
Brokamp: And he is right when you look at the typical target retirement fund. Morningstar does this report where they examine all the target retirement funds -- the recent ones. They looked at 49 series of funds, and they do find that generally speaking, those funds have about two-thirds of their allocation to large caps and only one-third to mid and small caps. I have to say I don't know exactly why they do that. I think it makes more sense to have a more evenly distributed portfolio allocation across all of those sizes.
Southwick: Did you offer up any percentages, or no?
Southwick: But what about bonds, though?
Brokamp: We'll talk about bonds later.
Southwick: OK, well, sorry!
Brokamp: It's just looking at stocks.
Southwick: Everyone, stay tuned! We're going to talk about bonds later. But if you're looking at just the equity slice of your portfolio...
Brokamp: I think you can go one-third small, one-third mid, one-third large.