In a previous article, I discussed a change of strategy for my Roth IRA account. Well, after a month and a half, this experiment is officially over. In theory, the strategy of the Value 40 Fund focusing on small cap, value, and momentum should work, and the fund's track record would be the envy of any fund manager. But alas, the month and a half since I implemented the strategy, I saw the value of my Roth IRA account drop from $74,464.55 to $68,173.39, an 8.5% drop, while the S&P 500 was down only 2.2% over this time-frame. Not good.
While I am not one to focus on short term performance, I realized that the strategy would probably not work for me for several reasons. The most important is the ridiculously high turnover, about 50% per month! Why is turnover such a bad thing? Answer: transaction costs. Although I don't pay commission in my brokerage account, I found that bid-ask spread took a huge bite out of my returns. The Value 40 Fund contains many thinly traded stocks where 1% spread is the norm and some even have spread up to 8%! Even if we assume just 1% spread, that would add up to 12% per year, so the fund would have to outperform the market by 12% just to break even. The odds are heavily stacked against that.
Another reason is time. Given the high turnover, it takes a lot more time to carry out all these trades and keep track. Time that I cannot always afford. Simple is good.
Another concern is holding speculative stocks during the late stage of a bull market.
Finally, the strategy obviously relies on the folks at U Mich continuing to publish the fund list every month and on my broker continuing to offer commission free trades. Neither of which is guaranteed. When a strategy relies on too many external factors, there are a lot more ways for it to go wrong.
So what do I do now? I thought about going back to my old Dogs of the Dividend Aristocrats strategy, but that also has been shown to be a subpar strategy. Maintaining 10 stocks portfolio also takes time. I want a simple strategy to give my portfolio a chance to outperform.
I don't want foreign stocks in my IRA, because I cannot get back the foreign tax withheld in a retirement account. I also don't need a lot of large cap, because the bulk of my taxable accounts and vast majority of my net worth is in large cap stocks. So that leaves with only one option: small cap stocks.
Small cap stocks have outperformed the market historically. So I will simply put all my IRA money into IJR, the smallcap 600 index ETF. This ETF has only 0.07% expense ratio and 13% annual turnover. IJR, with an average market cap of 1.6B, tracks a purer small cap index than other small cap ETFs like SCHA with average market cap of 2.6B or VB with average market cap of 3.5B. SCHA's lower expense ratio of 0.05% is tempting, but I think in the long run the small cap premium is the bigger consideration.
The danger with the approach is that small cap stocks tend to outperform mainly during the initial stage of a bull market, and we are well into the later stage now. But I am in for the long haul.
So IJR it is. All my IRA money will now go to IJR. Simple and gets the job done.
While I am not one to focus on short term performance, I realized that the strategy would probably not work for me for several reasons. The most important is the ridiculously high turnover, about 50% per month! Why is turnover such a bad thing? Answer: transaction costs. Although I don't pay commission in my brokerage account, I found that bid-ask spread took a huge bite out of my returns. The Value 40 Fund contains many thinly traded stocks where 1% spread is the norm and some even have spread up to 8%! Even if we assume just 1% spread, that would add up to 12% per year, so the fund would have to outperform the market by 12% just to break even. The odds are heavily stacked against that.
Another reason is time. Given the high turnover, it takes a lot more time to carry out all these trades and keep track. Time that I cannot always afford. Simple is good.
Another concern is holding speculative stocks during the late stage of a bull market.
Finally, the strategy obviously relies on the folks at U Mich continuing to publish the fund list every month and on my broker continuing to offer commission free trades. Neither of which is guaranteed. When a strategy relies on too many external factors, there are a lot more ways for it to go wrong.
So what do I do now? I thought about going back to my old Dogs of the Dividend Aristocrats strategy, but that also has been shown to be a subpar strategy. Maintaining 10 stocks portfolio also takes time. I want a simple strategy to give my portfolio a chance to outperform.
I don't want foreign stocks in my IRA, because I cannot get back the foreign tax withheld in a retirement account. I also don't need a lot of large cap, because the bulk of my taxable accounts and vast majority of my net worth is in large cap stocks. So that leaves with only one option: small cap stocks.
Small cap stocks have outperformed the market historically. So I will simply put all my IRA money into IJR, the smallcap 600 index ETF. This ETF has only 0.07% expense ratio and 13% annual turnover. IJR, with an average market cap of 1.6B, tracks a purer small cap index than other small cap ETFs like SCHA with average market cap of 2.6B or VB with average market cap of 3.5B. SCHA's lower expense ratio of 0.05% is tempting, but I think in the long run the small cap premium is the bigger consideration.
The danger with the approach is that small cap stocks tend to outperform mainly during the initial stage of a bull market, and we are well into the later stage now. But I am in for the long haul.
So IJR it is. All my IRA money will now go to IJR. Simple and gets the job done.
Thanks for sharing the result. I was skeptical, but applaud your courage to test it. Good decision. I hold VBR, but knew and have considered IJR, good fund.
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