Author Topic: Allocating 403(b) options: Stock Index or add Mid/Small Cap too?  (Read 4906 times)

Anti-ComplainyPants

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Allocating 403(b) options: Stock Index or add Mid/Small Cap too?
« on: December 22, 2014, 11:51:21 AM »
Straight to the point:

MMM teaches us to invest in Index funds. Up to this point, my 403(b) has been enrolled in an automated service that diversifies and  reallocates for the lazy investor. Now that I'm a bit more educated, I've decided to dis-enroll from that service to minimize my fees.

Unfortunately my employer doesn't have Vanguard as an option, but they do have a Stock Index Fund. My initial reaction is to simply throw all my money in there, but my adviser also recommended that I consider the Mid Cap Index Fund and Small Cap Index. They are modeled after the S&P 500, S&P Midcap 400, and Russel 2000 respectively. The fees are all between 0.33% - 0.45%, all of which are better than my current Guided Services Portfolio plan (0.65ish%).

So my question is: Should I simply invest everything into the Stock Index Fund, or also include the other two? If so, what allocations would I be looking at?

Thank you!

MDM

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Re: Allocating 403(b) options: Stock Index or add Mid/Small Cap too?
« Reply #1 on: December 22, 2014, 12:26:31 PM »
We will know the correct answer only in hindsight.

Keeping in mind "past performance is no guarantee...", see http://www.investinganswers.com/financial-dictionary/stock-market/sp-mid-cap-400-index-1228 and http://awealthofcommonsense.com/closer-look-russell-2000-appreciation-mid-cap-stocks/ for starters.

Depending on one's view of the future, defensible allocations are all over the map.  All in all I think your adviser made a reasonable suggestion.

James

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Re: Allocating 403(b) options: Stock Index or add Mid/Small Cap too?
« Reply #2 on: December 22, 2014, 12:53:52 PM »
What advantage are you looking for with the mid cap and small cap?

My understanding is that the smaller the cap the greater the risk and potential return. On a 10 year average the small cap is 9.4%, the mid cap is 9.9%, and the full index is 8.5%. (using vanguard funds for those numbers, compare with your fund returns and see what they show)

So long term you do have greater potential reward with the smaller cap funds, while also having higher risk.

My current decision has been to dump all funds into the full index. I have no bonds, no international, no small cap, just the full index. The fee is really small at .01%, so I know I'm not losing anything to fund costs. The .33-.45 costs for your funds seem a bit high, I would be interested what the full index fee is.

Edit: I forgot to mention I have about 20% of my funds in VGSLX, a REIT index that I chose to hopefully provide good returns. I don't add to that fund, all new funds get placed straight into the full index. I doubt you have a REIT index option to choose from, but that is where I look to gain some extra performance with a small percentage of my portfolio that may be similar to you putting 20% in small or mid caps. But the difference in your cost for those funds might offset additional gains you might get over time. The 10 yr average is just 8.8% so about the same as full index, but my theory is that is has a few more years of the recent high returns in store... we will see. It has 10 times the cost as the full index fund, but that is still only .1%.

I don't have a strong argument for why my idea is best, it's just what I've settled on. I had money in bonds until recently, and I had money in international index funds until recently. But I just can't justify them, and I can't justify the mid or small cap funds either. I want to own the full market, and the full index does that. I want high returns and the index does that. I don't know if international or small cap or bonds or anything else will do well in the future, all I have is the past to judge, so based on that I am happy with everything in full index for the next 30 years. That could change over time, but for now that is my plan and I'm happy to just let it ride there.
« Last Edit: December 22, 2014, 01:05:30 PM by James »

seattlecyclone

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Re: Allocating 403(b) options: Stock Index or add Mid/Small Cap too?
« Reply #3 on: December 22, 2014, 01:08:29 PM »
I think a total market index fund is the simplest building block for a portfolio, but it sounds like you don't have one available. However you can probably approximate one by purchasing some of each of the small/medium/large cap funds in an appropriate market-cap-weighted ratio. Take a look at the fund holdings and do some arithmetic based on underlying company size to figure out what a good ratio is for the funds available in your plan.

James

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Re: Allocating 403(b) options: Stock Index or add Mid/Small Cap too?
« Reply #4 on: December 22, 2014, 01:16:53 PM »
I think a total market index fund is the simplest building block for a portfolio, but it sounds like you don't have one available. However you can probably approximate one by purchasing some of each of the small/medium/large cap funds in an appropriate market-cap-weighted ratio. Take a look at the fund holdings and do some arithmetic based on underlying company size to figure out what a good ratio is for the funds available in your plan.


His plan does have a full index fund, he is wondering about weighting his investments by adding additional small and mid cap funds along with the full index fund he will have.

DrF

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Re: Allocating 403(b) options: Stock Index or add Mid/Small Cap too?
« Reply #5 on: December 22, 2014, 01:22:42 PM »
I read that he has three options:

1 fund like the sp500
1 fund like the mid cap 400
1 fund like the russell 2000

I know there are some white papers linked on other posts here in the forums, but I'm too lazy to find them right now.

The gist is that mid and small cap stocks added to a core sp500 portfolio increase return while simultaneously reducing risk.

I'd go with 80/10/10 in the order above. Rebalance 1x a year, or with your paycheck contributions.

Anti-ComplainyPants

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Re: Allocating 403(b) options: Stock Index or add Mid/Small Cap too?
« Reply #6 on: December 22, 2014, 03:07:53 PM »
I read that he has three options:

1 fund like the sp500
1 fund like the mid cap 400
1 fund like the russell 2000

This is correct.

It sounds like adding the Mid and Small Cap may increase my returns and increase risk, and I'll have to reallocate every once in a while. If it doesn't seem like a glaring disadvantage to dump everything into the Stock Index Fund (I assume this means Total Stock Index; it corresponds with the S&P 500 and is offered through VALIC) that's probably what I'll do. I intend to be leaving this job in 3ish years, at which point I'll probably roll this 403(b) into a Traditional IRA that is all Vanguard Total Stock Index.

MDM

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Re: Allocating 403(b) options: Stock Index or add Mid/Small Cap too?
« Reply #7 on: December 22, 2014, 03:18:47 PM »
...the Stock Index Fund (I assume this means Total Stock Index; it corresponds with the S&P 500...).
...I'll probably roll this 403(b) into a Traditional IRA that is all Vanguard Total Stock Index.

Not exactly.

From https://personal.vanguard.com/us/funds/snapshot?FundId=0085&FundIntExt=INT:
Quote
Created in 1992, Vanguard Total Stock Market Index Fund is designed to provide investors with exposure to the entire U.S. equity market, including small-, mid-, and large-cap growth and value stocks.

In other words, if you want to invest in the entire market now, you could approximate that by adding the small and mid cap funds to the (large-cap) S&P 500.

Again, no way to know what will do best in the future - just trying to ensure you are making an informed choice.

DrF

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Re: Allocating 403(b) options: Stock Index or add Mid/Small Cap too?
« Reply #8 on: December 22, 2014, 03:19:58 PM »
Now you made me look up the reference.  Here you go. http://www.morningstar.com/products/pdf/MGI_StockResearch.pdf

Adding mid or small cap stocks to a core sp500 fund DECREASES risk while simultaneously INCREASING returns.

The past may not predict the future*.

Anti-ComplainyPants

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Re: Allocating 403(b) options: Stock Index or add Mid/Small Cap too?
« Reply #9 on: December 22, 2014, 03:22:49 PM »
MDM and DrFunk, you are good people.

Thanks for the clarification and links. Acknowledging that the past may not predict the future, it seems like the best choice would be to allocate 80% large cap, 10% Mid, 10% Small.

Any last objections or votes of confidence?

MDM

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Re: Allocating 403(b) options: Stock Index or add Mid/Small Cap too?
« Reply #10 on: December 22, 2014, 04:39:15 PM »
MDM and DrFunk, you are good people.

Thanks for the clarification and links. Acknowledging that the past may not predict the future, it seems like the best choice would be to allocate 80% large cap, 10% Mid, 10% Small.

Any last objections or votes of confidence?
Thanks!  80/10/10 falls well within the defensible region.  Of course that region is bounded by 100/0/0, 0/100/0, and 0/0/100, depending on the assumptions one chooses....

Lots of good people here.  We all give about the same terms - a full refund if you're not satisfied with the results. :)

James

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Re: Allocating 403(b) options: Stock Index or add Mid/Small Cap too?
« Reply #11 on: December 23, 2014, 07:10:13 AM »
MDM and DrFunk, you are good people.

Thanks for the clarification and links. Acknowledging that the past may not predict the future, it seems like the best choice would be to allocate 80% large cap, 10% Mid, 10% Small.

Any last objections or votes of confidence?


I think that approximates the full index well and is a great plan.

GGNoob

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Re: Allocating 403(b) options: Stock Index or add Mid/Small Cap too?
« Reply #12 on: December 23, 2014, 08:06:04 AM »
Do you invest anywhere else...like an IRA or taxable account? You'll want some international exposure as well. Do you have any international index funds in your 403(b)? What about bond funds?

James

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Re: Allocating 403(b) options: Stock Index or add Mid/Small Cap too?
« Reply #13 on: December 26, 2014, 11:46:48 AM »
Do you invest anywhere else...like an IRA or taxable account? You'll want some international exposure as well. Do you have any international index funds in your 403(b)? What about bond funds?

I got rid of my international exposure, do you have a specific reason you feel that is needed? Obviously international interests are still represented in the US index, those companies don't only serve the US.

I don't see any reason to add a full international index, since there are so many regions that pull down the return on those stocks, I would rather stick with the higher return normally seen in US stocks. I could see investing in specific regions, say a pacific stock index or European stock index (those are vanguard funds), but then I start to feel like I'm making specific choices in an area that I don't want to make choices, and I'm not seeing any reason that would give me better stability or better returns.

Open to other ideas, but right now I'm of the opinion that international activities of US stocks is enough international exposure for me.

I also see no reason to have bonds unless you need them for stability. For early investors I just see them as a drag on long term returns.
« Last Edit: December 26, 2014, 11:51:30 AM by James »