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In going back over the comments on my last couple of articles, two reader concerns popped out at me. One, many of you still had faith in the Vanguard 500 S&P ETF (VOO/VFIAX) despite its concentration in giant AI-infused technology stocks. But, two, some readers would like to know how they might increase their diversification by adding a fund that did not always fluctuate in tune with one of the country’s most trusted large cap index funds.
I thought it might be helpful to hunt for a fund within the family that had a relatively low correlation with the broad market as represented by VOO. (I have used the ETF wrapper here but have provided symbols for the sister mutual funds.)
The most obvious place to start would be to look for an ETF whose style is less growth-oriented than the current S&P, which would be Vanguard Value (VTV; VVIAX) and Vanguard High Dividend Yield (VYM; VHYAX). I found their respective relationships with VOO to be .72 and .70, surprisingly low (to me) given that all three funds are large-cap vehicles. This only confirms for me that as currently constituted the S&P is quite growthy.
Well, investment style told us something valuable to know, but what about moving down the size ladder to small companies? Vanguard has several ETFs devoted to one or another style of small stocks, but the one most popular by far is the small-blend Russell 2000 (VTWO; VRTIX). Its correlation with VOO is .66, offering even more diversification than the two large cap value funds.
Now, what if we check out the one Vanguard fund that differs in both style and size from VOO– Small Cap Value (VBR; VSIAX)? Curiously, we get hardly any greater diversification here (,64), and the Russell 2000 ETF is far more heavily traded.
I figured we would reach diversification nirvana by traveling outside the U.S. via International High Dividend Yield (VYMI; VIHAX) and the FTSE All-World ex-US Small Cap (VSS; VFSAX). But the respective levels of commonality are .65 and .73, poor reasons to ditch the .66 correlation between VOO and the plain vanilla small cap Russell 2000.
So what have we found? Something potentially very useful, I believe. Depending on the size of the tweak, you can somewhat effectively diversify away from VOO’s growth tilt by adding the Vanguard Russell 2000 to your portfolio.
But before you start punching the keyboard, consider these caveats. Remember, you would be repositioning your portfolio for a reversal in the Magnificent 7, a return to favor of small cap stocks, or preferably both. If the promise of AI comes to fruition, how frustrated will you be to have missed out on a piece of the action?
Then, there’s this. When is repositioning a trade and when is it a long-term shift in emphasis? Is it Buffett’s “forever” or something more flexible if the Zeitgeist changes? Do you say investment should be boring because you’ve learned that trading is a costly waste of time? Or is it because you’re afraid to make any changes at all because you don’t feel knowledgeable enough about the market?
Likewise, do you trade because you’ve truthfully found an edge denied to most of us mere mortals, or because the poolside action at the club is too slow? The answers will be different for each of us, but they’re ones we need to know.
Steve, would you be interested in writing an article and offering your opinion on TRLAX?
Sure I would I’m just finishing up with Covid now, but I should be able to get to it soon as a Forum piece. I’ll let you know when.
What on earth is wrong with set it and forget it? In my IRA (for historical reasons) I have VFIAX, VEXAX and VTIAX. In my very small Roth I have VTSAX. In taxable I have VTSAX and VTIAX. I see no need to change anything except to rebalance occasionally to keep my stock/bond ratio in check.
As far as I am concerned tilt is another name for timing.
There’s absolutely nothing wrong with what you’re doing. In fact, one of your positions is very creative. VEXAX is Vanguard’s often overlooked extended market fund that fills in the small and mid-sized companies not included in the S&P 500. I do not know the size of your various positions, but you seem to have adequate international participation. Either you are a crackerjack portfolio builder or know someone who is.
Thanks, but no magic involved. Way back when my 401k offered a large cap and a small cap fund. When I moved the money to a Vanguard IRA I simply picked the closest funds. It has occurred to me to consolidate VFIAX and VEXAX into VTSAX.
My point was that you should aim for the total market and then leave things alone.
It seems that the diversification question comes to mind when one thinks that VOO is just one investment. Should we not see that VOO as 500 investments?
Not really! Many of the stocks are very similar and move in tandem with each other. Right now, the fund is 33% in one sector (tech) and should not be considered “diversified.”