Successful investing: size matters » PRINT

By Richard Buck
March, 2007

Most investors' money is concentrated in the stocks of large companies. As Richard Buck points out in this article, that means a lot of people leave a lot of money on the table. Included are seven dramatic charts you have probably never seen.

This article contains seven charts that very few investors have ever seen. That's a pity, because they show something very important about making your equity investments work hard for you. In a phrase, they show that size really matters.

To see what I'm getting at, look at Figure 1. It shows cumulative returns for 11 "slices" of the U.S. stock market for the years 1965 through 1968. Except for the one labeled "S&P 500", each slice represents one tenth of the stocks, depending on the size of the companies. It shows that the smallest companies, represented by the 10th decile (explained in a moment) rose much faster than the largest companies, represented by the first decile.

Since 1968, stock-market leadership has swung back and forth six times between large companies and small companies. You'll see that in Figures 2 through 7.

The charts are reprinted with permission from Dimensional Fund Advisors. To understand the numbers under the bars, imagine that you ranked all U.S. stocks by their market capitalizations (total number of shares times the current share price) and then divided them into 10 equal groups. Each group would represent one-tenth of the whole, or a "decile." In the charts, each decile is represented by a bar, with "1" being the largest 10 percent of companies and "10" being the smallest 10 percent.

Figure 1 shows that the smallest stocks were up about 350 percent in those four years while the largest stocks gained less than 50 percent. As you can see from Figure 2, the pattern reversed itself from 1969 through 1974; as the market declined, small-company stocks tumbled much farther.

You'll see reversals in 1975 (when small-company stocks took the lead), in 1984 when bigger became better, and in 1991. Figure 6 shows how large companies soared during five years of the great bull market of the 1990s. Figure 7 shows that small-company stocks far outpaced large ones in the eight-year period from 1999 through 2006.

The point is that over periods of at least a few years, small stocks and large stocks move at different times. Rarely have both been extremely productive at the same time. And it's rare that both are extremely unproductive at once.

What should an investor make of these charts? They show history, and history (as always) teaches us lessons but never gives us instructions for the future. To me, the charts' most obvious lesson is that the size of companies really does make a difference. The second most obvious lesson is that one size doesn't fit all investors forever.

Investors place great faith in recent performance, and it is easy to believe today (as it was easy to believe in 1969, 1984 and 1994) that small-company stocks are the best way to invest. But easy isn't necessarily the same as true. Over this span of 42 years, investing only in large-company stocks wasn't a wise move. Neither was investing exclusively in small-company stocks.

These charts show relative performance, and relative performance seems to persist in trends that last at least a few years. However, there is no predictable pattern of how long these trends last. In the seven time periods shown here, big-company stocks were the winners in three periods spanning 18 years. Small-company stocks did better in four periods totaling 24 years.

We believe investors should own both small-company stocks and large-company ones, preferably in low-cost index funds that own stocks by the hundreds instead of by the dozens. Those funds will be most likely to capture whatever "size matters" effect is current. And if you rebalance annually, you'll always be ready for whatever is next.

Investors sometimes ask us how long the current small-company stock run will last. Of course we don't know. But with the information in these charts, you now know as much about that as anybody.

Company Size Impact (1965-2006)

Source: Dimensional Fund Advisors. Note: Figures are not all drawn to same scale.

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