Wes Crill has a chart that makes people lean in. Put $10,000 into small, cheap, highly profitable U.S. stocks in July 1963. Hold on. By this July you'd have $208 million, before taxes and fees. Then Crill, a senior investment executive at Dimensional Fund Advisors, tells you why nobody would have held on. Spencer Jakab lays it out in Wednesday's Heard on the Street column.
The three ingredients are old friends to finance professors. Small companies. Low prices next to what the business owns and earns. High profits. Each one has beaten the market over long stretches. Crill found that stacking all three didn't cancel out. The combo returned 17.1% a year since 1963. The whole U.S. market did 10.9%. That gap, 6.3 points a year, is what turns $10,000 into more than 30 times what the market made.
The part the chart hides
Few stocks pass all three tests, so the basket is small. Small baskets swing hard against the market. Over one 12-month stretch it trailed by 38.4 points. Over one 36-month stretch it trailed by 72.6 points. Picture three years of your neighbor's index fund running away from you. That gap between your fund and the market is called tracking error. Crill borrows Jack Nicholson's courtroom line for it. Investors, he says, can't handle the tracking error.
Jakab is careful here, and so is Crill. He isn't selling a product. The future won't copy the past. Even a plain index fund is hard to hold. Jakab adds a sobering note. Buy a plain index fund at the wrong moment and you could wait decades and still trail the safest bonds. Crill's point is about why free lunches stay on the table. The smart money knows about them. It just can't stomach them either.
Our read
This is Investments and Risk (IN04), and it's really Behavioral. A strategy earns you nothing if you sell it in year two. The 17.1% belongs only to someone who never needed the money and never opened a statement. Someone whose spouse never asked why the account was down while everyone else's was up. That person is rare. Our books hold a little small-cap value as a pinch. Avantis Small-Cap Value (AVUV) is in one book at 5% and Vanguard Small-Cap Value (VBR) in two, held at weight, nothing added. We don't recommend the factor as a main course, and this isn't a case for it. It's a case for sizing anything to the lag you can live through.
Here's the check for your own plan. Open your 401(k) menu and find the small-cap value fund, or any fund you picked because it beat the market in a backtest, a test run on past prices. Look at how much of your balance sits in it. Then ask yourself whether you'd still hold it in year four after three straight years behind the market. This mix once trailed by 72.6 points over three years. If the honest answer is no, the position is too big. A smaller slice you'd actually keep beats a bigger one you'd dump at the bottom. That's the kind of thing we go through in a plan review, and the time to size the umbrella is a dry day.