Dr. Don, I am 38 years old. I plan to invest this retirement portfolio for at least 25 years more, and it is all invested in Roth IRA accounts, so tax-efficiency is not an issue. I was over-weighted in large growth stocks in the '90s. I didn't know what I was doing, but lucked out due to large-cap dominance. More recently, I've lost 12% over the past 12 months. Now I prefer my portfolio to lean towards value or a blend of growth and value, and don't want it to have a heavy growth tilt. Besides, the S&P 500 has an equal return with the large growth group over the past 3/5/10 years, so why even bother with the extra risk of growth (that's my thinking anyway)? I like indexing, but believe that active management may be better for international and small-cap. I don't like indexing the Wilshire 5000 or Wilshire 4500 because, of all of the highflying tech (small companies included), I like the S&P indexes best. Lots of people tell me to avoid mid-caps altogether and just do large and small caps. But I like mid-caps. They seem to do well and I think it's too important a part of the market to bypass. What is your mid-cap opinion? I prefer to lean my portfolio towards value (70/30 or 60/40), and in global investments I prefer value/hedged. I don't like any large-cap indices -- I've looked at S&P, Russell, DFA and Wilshire. Dodge & Cox's Stock fund and the Clipper fund look the best to me of the large value funds. I like small-cap value and don't like small growth at all, but want to own a small piece of it, thus the investment in the Dreyfus Small Cap index. The S&P small-cap kicks Russell 2000's butt most of the time. I don't like sector bets and high-tech scares me. I currently have about 96K in my account, and I am investing $4,000 per year into Roth IRA accounts. Please let me know your opinion. JG P.S. One correction: When I say, "I don't like any large-cap indices," I mean I don't like any large-cap
indices. I obviously love the S&P 500 index, but don't like the S&P Value index; it seems too similar in trend to the overall index.
You've painted yourself into a corner with the parameters that you've placed on your portfolio. You don't like growth, you don't like tech, you don't like large-cap value funds and you don't want to make sector bets in your portfolio. That leaves your portfolio preference weighted towards a mid-cap and small-cap value portfolio, but since perceived value is often sector-driven, you wind up overweighting undervalued sectors in the marketplace. Compared to the S&P 500, your portfolio is overweighted in financials, industrial cyclicals, consumer durables, consumer staples and services, while accomplishing your goal of underweighting technology. But if you compare your portfolio to a small-cap value portfolio, which is how
classifies your portfolio's investment style, you're overweighted in consumer staples, health and technology.
What's interesting through all this is that you're actually invested pretty much where you say you want to be invested. You made an exception for the Clipper fund in the large-cap value area. Standard and Poor's decomposes its S&P 500 Index into a growth group and a value group, with the value group currently representing 53% of the index. So your Fidelity Spartan 500 Index fund represents a solid core holding for your portfolio with its blend of value and growth and its emphasis on large-cap holdings. The Dreyfus MidCap Index fund has a stated growth emphasis, but according to Morningstar is currently invested as a mid-cap blended fund. So overall your portfolio fits your parameters.
Growth vs. value investing is as thorny a topic as
active vs. passive management. A growth investor chooses his investments based on the earnings growth he expects to see in a company or industry sector over time. He's willing to pay high a P/E multiple for a company when he expects earnings to grow rapidly, because when the earnings start coming in, the P/E multiple will come back down from the stratosphere. When an earnings disappointment takes the wind out of the company's sails, the stock typically retreats to both a lower price and lower multiples. The paradox is that a growth stock can be beaten down to the point where it becomes a value play.
Most stock analysts like to look at forward P/E multiples because when you buy a stock today you're buying its future earnings, not its past (trailing) earnings. The S&P 500 Index has historically sold at a P/E multiple of about 15 times trailing earnings. It currently is selling at 21.5 trailing earnings, 22.6 times 2001 estimated earnings and 18.6 times estimated 2002 earnings, according to the S&P Index Services.
The total return that you earn on a stock investment comes from growth (price appreciation) and income (dividends). Value investors of course don't invest just in income stocks. They're looking for price appreciation from their holdings just like the growth investor. The difference is in what the value investor is willing to pay upfront for those future earnings. There's been resurgence in value investing in the past year and a half after a period dominated by growth investing.
The key to successful value investing is being able to separate the wheat from the chaff. Stocks trade at low multiples for a variety of reasons. Being able to distinguish which of these stocks represents value and which will continue to fade is the hallmark of a good value fund manager. You're right to think that value indexing isn't the way to go.
Once you get away from index investing you'll struggle to avoid sector bets in your portfolio. Indexing gives you less technology exposure than it used to, but you'll have trouble avoiding that too.
Value funds are looking for the market to change its thinking on a company's future prospects. Growth funds are looking for a growth company's future prospects to justify a high stock valuation. There may be more downside risk corresponding to a growth stock's earnings disappointments than a value stock's stagnant multiples. So wanting a value emphasis in your portfolio is your reaction to the market selloff over the past year.
The thing to remember is that, even with the losses in the S&P 500 over the last year and a half, it still has an annualized return of about 14.5 % over the last 10 years even after considering the nearly 22% it lost over the 12 months ending March 2001. Don't be like a general fighting the last war. The speculative bubble in technology has been vanquished. A lot of money was lost, but the lesson to be learned isn't to avoid growth stocks.
With a $4,000/year annual contribution and a portfolio worth about $98,000, you'll end up with close to a million-dollar portfolio 25 years from now if you can earn an average return of 8%. Will that be enough for a comfortable retirement? It depends on what other sources of retirement income are available to you, and how you plan to live in retirement. Try using
retirement calculator to estimate what you'll need in retirement.
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Dr. Don Taylor has been an investment professional for nearly 15 years, most recently as the treasurer for a nonprofit organization where he managed more than $300 million in assets. He is a chartered financial analyst, holds a Ph.D. in finance and has taught investment and personal finance courses at the University of Wisconsin and at Florida Atlantic University. At the time of publication, he owned none of the funds or stocks mentioned, though positions can change at any time. Dr. Don's Portfolio Rx aims to provide general investing information. Under no circumstances does the information in this column represent a recommendation to buy or sell. Dr. Don welcomes your inquiries and feedback at