Astones wrote: ↑Tue May 11, 2021 7:59 pm
By the way, for the 100/0 fans, why don't you go all in in your analysis and reduce your portfolio to small cap value ?
If reducing volatility is nothing to be bothered about, then I guess the wisest choice would be to go 100% SCV .
Why should we draw the line at VTI ?
So personally, I think your question is a good one. As an aside, I don't think the additional risks associated with things like the small and value factors are best understood as volatility risks, but that isn't very important in this context. The question would be more general--as long as we are not trying to create a portfolio which has the best risk-adjusted
expected rate of return, just the highest long-term expected return, wouldn't it make sense to load up on factors which are expected to increase the long-term rate of return, regardless of how to understand the associated risks?
As another aside, I also think you could ask a similar question about leverage--if you are not going to adjust for risk in your evaluations, why stop at 100% stocks when you could leverage up to more than 100%?
And I think some people do in fact follow that logic--they invest in higher than market cap weights of SV and/or perhaps other factors. Overweighting EM might be another such strategy. They might use leverage of some kind (if only in the form of carrying low-rate loans like mortgages and student debt while also investing in stocks). And so on.
Of course everyone draws the line somewhere. There is implicitly some sort of risk at some level they just are not willing to take. But I think it is true that rigorously using the same criteria being used in this discussion to select a 100% stock portfolio, you'd probably end up choosing some leverage, and would apply it to some sort of non-market-cap-weighted portfolio.
So I would tend to agree that if you are a long-term-only investor, and you are not investing your long-term-only portfolio like that, you have not really taken this sort of logic all the way to its conclusion.
And maybe there are good reasons for that. But then you would have to check carefully to make sure whatever reasoning you were using not to go with a leveraged non-market-cap-weighted long-term-only portfolio did not also undermine the argument constructed here for 100% stocks.
And I think you are further right that reasoning to the effect that we should mirror how the global participants in U.S. stock markets have in the aggregate allocated their capital between the various U.S. stocks does
undermine the 100% stocks argument offered here. Because, those same global participants in U.S. stock markets do not
just allocate capital to U.S. stocks. They don't just allocate capital to stocks in general. They also allocate capital to, among other things, bonds! So if you are committed to the notion that we should be allocating our capital the same way that those people in the aggregate allocate their capital, then we should be following their lead consistently. And yet the logic here is rejecting the idea of mirroring their allocations to bonds.
So where does this leave us? I'm not sure, but I do think if you really poke at most people's reasoning as to their portfolio allocation decisions, it is rare to find someone who has truly taken one specific theory entirely to its logical conclusion. Maybe a few people have really tried to mirror the capital allocations of the aggregate of global investors. Maybe a few people have really tried to maximize expected returns with factors, leverage, and anything else historical research would support. But I think most people end up with some sort of hybrid approach that in some way makes compromises, exceptions, or so on with respect to their nominal investment philosophy.