“April showers bring May flowers.” Can the same be said about the recent GOP tax reform and stock market returns?

I don’t know and neither does anyone else!

What does the evidence tell us?

Dimensional Fund Advisors’ Apollo Lupescu answered this very question when he joined us last fall for presentations in Houston and St. Louis.

Relive it here.

Do politicians affect the market? from Hill Investment Group on Vimeo.

Apollo asserts, “The tax policy, the president and the politics have much less to do with the market than the fundamentals.” We agree.

We were pleased to have Dimensional’s Vice President Apollo Lupescu, PhD at a pair of events we held in Houston and St. Louis. Apollo spoke about the historical context of modern investing, the essence of an evidence-based approach, and the future of our community.

What does history tell us about how the financial future might look? Be on the look-out for a recorded version of Apollo’s St. Louis presentation, which we’ll be sharing soon via our blog/newsletter.

Dimensional Fund Advisors is a hugely important alliance for Hill Investment Group, and yet this is the first event we’ve done with a member of their team conversing directly with HIG’s clients and friends. Despite having a low profile, Dimensional currently manages $518 USD billion across eight countries (as of June 30, 2017). How have they done it? Through sharing ideas that make sense and by creating solutions that reflect their beliefs (and ours).

We also respect Dimensional as a thought leader, regularly publishing content that helps change the way investors think. We like one of their recent pieces, “Lessons for the Next Crisis,” which points out we’re nearing the ten-year anniversary of the beginning of the Great Recession. That’s not exactly an event to celebrate, but it’s important to apply what we learned from it the next time we’re in a bear market, once again feeling like there’s no end in sight. As Dimensional says (and buttresses with evidence-based illustrations):

“Capital markets have rewarded investors over the long term, and having an investment approach you can stick with—especially during tough times—may better prepare you for the next crisis and its aftermath.”

Well said, Dimensional.

Quick, what’s the difference between a market-cap-, equal- and price-weighted stock market index? Fortunately, if you’re not sure, our friends at Dimensional Fund Advisors just published an excellent piece on this very subject. We invite you to read it here, but here’s our overview.

If you think of a market as a big box, there are several ways each stock that belongs in that box might “weigh in” to help fill it:

Market-Cap Weighted – If we fill a market box according to each stock’s market capitalization (share price multiplied by shares outstanding), the stocks with the biggest market caps (e.g., Apple stock –  AAPL) weigh the heaviest, or occupy the most space, as Dimensional depicted here:

Equal Weighted – If, each security is instead given equal space in the box regardless of its market-cap, an equal-weighted market will look more like this:

Price Weighted – As described in this recent New York Times piece (which may require a subscription to access), the Dow Jones Industrial Average is the only popular index that uses price weighting, where the highest-priced stocks take up the most space. (Almost everyone agrees, price-weighting is pretty arbitrary, especially since the Dow tracks only 30 U.S. stocks to begin with. But as the world’s first and oldest index, the venerable Dow essentially gets to do as it pleases.)

So what does all this mean to you as an investor? As Dimensional’s illustrations depict:

• If you were to invest all of your money in a single market-cap-weighted index fund, you’d end up holding a much heavier allocation to large-cap stocks, be they value or growth.
• If you were to invest everything in an equal-weighted index fund, you’d end up holding more small-cap stocks than would otherwise be warranted by their cap-weighted presence in the total market.

Now, here’s where things get a little complicated, so bear with me. At first glance, you might conclude you’d be best off investing in an equal-weighted index fund, to capture more of the higher expected small-cap value premium. After all, that’s where the biggest small-cap value “blob” appears, right?

Not so fast. First, we’ve got to remember that an index is just a theoretical collection of stocks. When an investor or fund manager seeks to replicate an index by placing actual trades on those stocks, they run into real-life trading constraints. This is especially so when tracking an equal-weighted index, where far more frequent trading is likely to be the norm.

Put plainly, keeping up with the evolving components in an equal-weighted index can get very expensive, very fast.

Dimensional explains:

“[U]sing a systematic and purposeful approach that takes into consideration real-world constraints is more likely to increase your chances for investment success. Considerations for such an approach include things like: understanding the drivers of returns and how to best design a portfolio to capture them, what a sufficient level of diversification is, how to appropriately rebalance, and last but not least, how to manage the costs associated with pursuing such a strategy.”

Which brings us back to evidence-based investing as we know it. Want to know more? Here’s a past post on index- vs. evidence-based investing. Or just give me a call to continue the conversation.

End notes:
Exhibit 1: For illustrative purposes only. Illustration includes constituents of the Russell 3000 Index as of December 31, 2016, on a market-cap weighted basis segmented into Large Value, Large Growth, Small Value, and Small Growth. Source: Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. See Appendix (on page 3) for additional information.

Exhibit 2: For illustrative purposes only. Illustration includes the constituents of the Russell 3000 Index as of December 31, 2016 on an equal-weighted basis segmented into Large Value, Large Growth, Small Value, and Small Growth. Source: Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. See Appendix (on page 3) for additional information.