DHWA Investment Update | 2010  Vol. #1

Size Matters - Even When Investing

Part of our client education deals with describing how size and value mean a lot when choosing asset classes to use when building a portfolio. Regardless of whether you are dealing with a domestic, foreign or emerging country's stock market, the size of the companies involved, and the valuation aspect of the company's earnings have the greatest importance of how much additional return an asset class can bring to a portfolio over longer periods of time.

You've probably heard us preaching this before: "Small beats Large, and Value beats Growth." This proposition directly relates to the risk level of those two asset classes. Small companies are typically riskier than large, and therefore investors as a whole demand more return in order to own them. Value companies typically have "uglier" earnings than growth companies. Again, investors demand a greater return in order to own these ugly stocks. So there is a great reason why both small stocks and value stocks, taken in large groupings (asset classes), show superior returns.

Check out the chart below:


Multifactor data provided by Fama/French.
SmB and HmL research factors. Past performance is not a guarantee of future results. Values change frequently and past performance may not be repeated. There is always the risk that an investor may lose money. Securities of small firms are often less liquid than those of large companies. As a result, small company stocks may fluctuate relatively more in price. Even a long-term investment approach cannot guarantee a profit. Economic, political, and issuer-specific events will cause the value of securities, and the funds that own them, to rise or fall. Because the value of investments will fluctuate, there is a risk that investors will lose money.

The top chart shows 5 year moving average returns of US Small vs. Large stocks. The blue bars show times when small beats large, the red, when large beats small. Similarly, the bottom chart shows 5 year moving averages of US Value vs. Growth stocks, with blue bars showing when Value wins, and red bars showing when Growth is superior.

You should want adequate representation of both Small and Value in your portfolio, and we make sure our clients do indeed own them. But remember, this only works with broad asset classes made up of hundreds or thousands of individual stocks. Never speculate on individual small and value stocks. That would be extremely risky, and more gambling than anything else.

Unlike the beach, investing is an area where small and ugly turns out to be the ones you should want to hang out with for the long term.

If you have any questions on this or any other investment topics, please contact us.

DIXON HUGHES WEALTH ADVISORS

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