Tilting To Small And Value Stocks – Yea or Nea?

Tilting to small-cap and value stocks is all the rage these days in the portfolio management world. There’s even a company pretty much devoted to it, Dimensional Fund Advisors (referred to as DFA in finance-nerd sectors), whose funds have rapidly gained notoriety over the past few years. There are plenty of prominent advisors who advocate some sort of tilting strategy.

But is tilting right for everybody? I don’t believe so. In fact, I would say tilting is probably a bad choice for a significant majority of investors. So who should tilt? Let’s examine the subject.

I Personally Tilt My Portfolio

I should first point out that I personally tilt to small and value stock, as you can see by checking out my asset allocation. I clearly believe I am the kind of individual for whom tilting is a good idea because I have a high risk tolerance, can tolerate tracking error, and am fine with my portfolio under-performing a bit if the small-value premium doesn’t show up.

Should You Tilt?

Tilting is risky. And while the concept is relatively easy to understand (I won’t go into it here), the results aren’t necessarily guaranteed to show up and even if they do, it may take a lot longer than you think.

You Should Consider Tilting If…

  • You have a higher than average risk tolerance - Holding more small and value stocks is inherently riskier than holding stocks in their market weights.
  • You don’t mind under-performing for long stretches - While the small and value premiums have been fairly persistent over time, there have been periods of several decades at a time where the strategy simply did not work. Over a 40 year investing career you should be okay, but you shouldn’t expect to over-perform over shorter periods. Not even 10-year periods are long enough for the small/value premium to reliably show up.
  • You understand the premium might NEVER show up - Vanguard, perhaps not surprisingly, has come down on the side of full-market indexing over small/value tilting. There is a significant amount of research out there concluding that even if the small/value premium actually exists (which is open to debate), it might not be exploitable by retail investors due to costs and lack of access.
  • You don’t mind paying higher costs - Do costs matter in investing? Absolutely! Lower is generally better, but some investors, including me, believe it’s okay to pay a bit more for small/value exposure if the diversification benefit is significant enough. Is it significant enough? I believe so, but I can’t prove it.

You Should NOT Tilt If…

  • You don’t know what this article is even about – Just stating the obvious…
  • You have an average or lower risk tolerance - If you sold stocks during the last downturn, you almost certainly shouldn’t be tilting your portfolio.
  • You don’t like under-performing the broad market - The best way to avoid under-performing the broad market is to own the broad market. While it’s possible you might earn a slightly higher return over the long run by tilting, you certainly won’t do so every (or even most) years. If you’re prone to worrying, do yourself a favor and stock with the total market. You’ll sleep better at night.
  • You prefer simplicity - There’s nothing particularly simple about tilting. At best, you’re looking at an extra 30 minutes or so of work when it comes time to rebalance. It’s also more complicated to choose your allocation to begin with. And alas, there are no all-in-one balanced or target retirement funds I’m aware of that utilize a portfolio tilt. If you want to keep it simple, I would forget about tilting altogether. This is a compelling reason for some, although managing an extra fund or two doesn’t strike me as particularly time-consuming.
  • You don’t trust back-testing - Most of the evidence for the small/value premium is based on back-testing performance data, which is known to be an unreliable way to uncover market insights. I wouldn’t blame you at all if you chose to disregard the research.
Do you tilt your portfolio? Why or why not?

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