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Mindy: You’ve likely heard this in the fire community before. You need small cap value exposure for long-term performance. Buy AVUV. But why? What even is small cap value? And why does everyone recommend AVUV specifically over the dozens of other small cap value funds out there? If you’ve been confused about small cap value funds or wondering if you should add AVUV to your portfolio, this episode finally makes it clear.
Mindy: Hello, hello, hello and welcome to the Bigger Pockets Money podcast. My name is Mindy Jensen and with me as always is my large cap co-host, Scott Trench.
Scott: Thanks Minnie, great to be here. Uh, together we make a blend, but you uh provide all the value here at Bigger Pockets Money.
Scott: All right. Today we’re going to get some answers about small cap value and specifically what these various options in the small cap value world do, what what is the difference between a fund, you know, one fund versus another, how they classify small cap value, how they invest or exit into these companies. To get these answers, we have brought on Frank Vasquez from the Risk Parity podcast back to the Bigger Pockets Money podcast. This is number three or four, I think here at BP Money, to break down exactly what small cap value investing is, why it matters for financial independence, and what the difference is between the various ETF options and what makes one good versus another. Frank, welcome.
Guest: Thank you. It’s good to be back.
Mindy: Okay, Frank, let’s set the stage. What are we talking about today? What What are small cap value funds and what does small cap mean?
Guest: This research goes all the way back to the 1990s. It’s famous research from Eugene Faman and Ken French. And they did a long series analysis going back to the 1920s of the stock market, splitting the stock market up into what they call factors. Factors are just characteristics. And so two of the main factors they looked at were size in terms of how big the company is, so you can rate your companies, they basically categorized them small, medium and large based on how big they are, uh, in terms of their market capitalization, how much they’re worth. They also looked at what is called the value factor, but it’s it’s basically between value and growth is the spectrum we’re talking about. Value companies are typically companies in stayed industries, like Proctor and Gamble is a good example of a value company. They’re basically companies that typically are paying a lot of earnings for how much they cost essentially. So they include things like high dividend companies, but they are all companies that tend to be in these kind of industries like utilities and consumer staples and and heavy industry and things like that. Now, the growth companies are all of your tech companies. And so they are expected to grow a lot. They do not have a lot of earnings for how much they cost. So if you’re familiar with what they what do you call a PE ratio, a growth company has a higher PE ratio and a value company has a lower PE ratio. But I think the most important thing to understand about the difference between growth and value is it is a way of of distinguishing the types of companies we’re talking about because basically the same types of companies fall into the value category, whether they’re insurance companies or utility companies or consumer staples, and the same kinds of companies end up in the in the growth side, whether they’re biotech companies or your basic large cap tech companies. So our US market is dominated by growth companies and large cap growth companies. The way this has developed over time is this is kind of a way of segmenting the market and if you go to a place like Fidelity or Morningstar and look at an analysis of a fund or a company, it will give you this what they call style boxes. And this thing looks like a Tic Tac Toe board. And so on one axis, if from left to right, it is usually value on the left and growth on the right and then they do small to large, small on the bottom and large on the top. And then they divide it into nine boxes. And so you can categorize things by which box they’re in. If it’s like a tech company, like a Tesla, that’s going to be up in large cap growth, if it’s a small insurance company or something, it’s probably going to be over in midcap value or small cap value. But this is a convenient way of segmenting the market that has developed and this has been going on for the past 30 some years now. So it’s very well established that this is one of the primary ways of segmenting the stock market into categories. The other main way that stock market is usually categorized is by sector, in which case there are usually 10 or 11 sectors defined, so you have like a real estate sector, and a utility sector, and a consumer stable sector and a communication sector. Those overlap with this growth and value thing because usually one sector type tends to be more growthy and one other ones tend to be more valueey. The growth versus value is actually a kind of shorthand way of saying, okay, these are these kind of sector companies and growth are these kind of sector companies. And that really is the source of the the diversification between the two of them. I mean, they’re literally different kinds of companies you’re talking about. That’s why you look at this as a source of diversification, not on some randomness, but on actual what kind of business we’re talking about.
Scott: There’s a reason, you know, you can filter the stock market in a in a multitude of ways. There’s a reason why people have filtered the market for small cap value in particular, and it’s because small cap value implicitly drive long-term returns, and therefore it makes sense to relatively wait your portfolio more towards something like a small cap value fund or portfolio in addition to having some exposure to blended or large cap growth in there. Is that, is that the correct interpretation and can we read your risk parity portfolio that you came on and shared with us as implicit acknowledgement of that, that, uh, analysis?
Guest: There are two issues here. One has to do with diversification and one has to do with performance. Now, the reason people have become tranched with small cap value in particular, and I’m always thinking of these style boxes, so the lower left-hand corner of the style boxes is historically and one of the things that Faman French found is that those kinds of companies tended to outperform the market over long periods of time. There is a raging debate going on now whether that is still true or not. But if you look at and I think of the four different main boxes, the corners, so small cap value, large cap value, large cap growth and small cap growth. If you just look at those segments, you will find that small cap value and large cap growth tend to do either as good or better than the overall market. That large cap value, which includes all of your like heavy dividend paying stocks tends to underperform the market but be less volatile. and small cap growth is something you probably don’t want because it’s both it’s highly volatile and basically does not have a good risk reward kind of characteristic. So, where people have focused then is the large cap blend or large cap growth category, which includes all of your basic index funds. That’s that’s where you’ll find the S&P 500 fund. That’s where you’ll find VTSAX. Those are large cap blend or large cap growth funds in essence. And so pairing that up with a small cap value fund gives you a good diversification both on the size and then the kinds of companies you’re talking about really is what you’re going for there. And so for me, the important thing is the diversification because over time, you’ll see that these two categories of funds tend to perform differently at different times. We are in one of those times right now that if you look at small cap value this year has outperformed the main market by 10%. Over the past six months has outperformed the S&P 500 basically by double and this happens from time to time that one or the other one is outperforming. And if you have two things that are basically performing the same way over long periods of time, but perform differently at different times, that is a fundamental principle of diversification. You want to have both those things. So when one is high and the other one’s low, you sell the high one, buy the low one and as you go over time, that is how you get a bonus out of diversification by holding more than one thing that is performing differently at different times. And so that’s the draw or the attraction to this, at least for somebody like me, I don’t anticipate or believe that small cap value is necessarily going to outperform the market. It might, but it doesn’t need to. From my perspective, as long as it over time performs at least as well as the market and I think it will, then it’s a good thing to hold with something like a S&P 500 or a VTSAX fund because they’re well diversified.
Scott: Perfect. And and again, just to hammer the point home though, that small cap value is special in the relative sense, as an aggregation of sophisticated historical work talking about correlations and return profiles relative to total market index funds or the S&P 500. And that is why specifically we’re talking about it today in there. And and and that’s why we’re not talking about industrials as a carve out, right? Or or midcaps or you know, large cap value. We’re talking about small cap value specifically because of its special dynamics there, um as heavily researched by legions of investor nerds over the years.
Guest: Yes, and it’s still well accepted as a methodology. So if you listen to somebody like Liz Ann Saunders at Schwab, who’s the head of the investing there, she talks a lot about factor investing and diversifying by factors. This whole area developed as a method for financial advisors, going back to the 1990s, there was a fund company called Dimensional Fund Advisors who is sort of the goat as far as factor investing is concerned. They developed a whole series of funds and a methodology and they used to sell that through as a like a proprietary thing through financial advisors. So you couldn’t get access to their funds unless you hired a DFA financial advisor, and of course, you have to pay for that. And then you could get access to these kind of factor funds. That has changed in the past eight years in particular that instead of having to go through a DFA financial advisor to get access to this kind of investing, you could now get it pretty much for free because all of these things are now offered both in DFA funds and ETF form, and then an offshoot of DFA is a company called Avantis, which is doing the same kinds of things, creating the same kinds of funds. So this has been going on for a very long time and it used to be a proprietary thing, but the development of investing as a financial technology is how I view it.
Scott: Let’s get into definitions here, right? This is like the next layer, right? If you accept the argument that small cap value or factor investing and small cap value is is should be one of the a a key factor in your portfolio, then it’s which fund, or how do I define small cap value and invest according to that that thesis. And this is where Paul Merriman kind of gave us a glimpse, hey, there’s you know, the the very two funds that both claim to be small cap value can perform wildly differently because of definitions in terms of how they enter, how they exit, and what they define as small cap value. So, can you help us understand the landscape here and defining small cap value and begin to help us narrow in on good versus bad?
Guest: It’s interesting. So, so the reason Paul Merriman does what he does is his old firm before he quit being a financial advisor was a DFA financial services. And and so he’s basically taking those principles and now released them essentially to the public if you will. Talking about funds in particular, okay, all of these funds are what you would call index funds. And let’s go back and define what an index fund is because I think this is actually misunderstood by a great portion of the investing public. I think there’s an idea because we’ve heard so much about the S&P 500 or a total market fund like VTSAX, that that is an index fund and everything else is not an index fund. And that’s not true. What an index fund is, it’s just a method of categorizing an index is a method of categorizing a group of stocks. It basically has some criteria and then looks at it and says, okay, is this stock in this index or not? And then the other categorization that an index fund does is well, how are we going to wait these in a grouping? Are we going to have the index invest more in the biggest companies like an S&P 500 or VTSAX, or are we going to wait it in some other way? And so all an index fund is doing is running an algorithm. It would be better to describe these as algorithmic funds because this is how it works. And what an index fund does is take an index, run computer algorithm on it to take all the stocks and categorize them as to whether they should be in the index or not, and then how much should be the value of them. And they run this thing every few months and then they adjust the index fund by that. And so a common thing people talk about is it it’s self-cleansing, like a easy bake oven or something. All that function is is the function of the algorithm going back through and re-running the algorithm and then rearranging the stocks based on what the landscape looks like today in terms of the algorithm. So all of these small cap value funds are index funds. and the way that they run them is they come up with an index saying, okay, well, how small is small enough? And so it’s it’s literally this size company up to this size company. and it actually does have a bottom cutoff because they’re not including like penny stocks and micro cap things. So it’s it’s from this big to this big and I don’t recall the exact numbers there. And then usually on the value side, they are looking at these PE ratios or something like that where they are saying, okay, this has a price to earnings ratio in this range. And there are several other metrics you can use for that, but it’s the same idea. So it’s looking through all the stocks in the world and saying, okay, the the algorithm looks at it and and says, okay, does it fit in this index or not based on the computer program? And then let’s just arrange them and then to manage it, it just runs it periodically and they just change the index. What’s interesting here is there are different indexes for small cap value in particular. There’s three common ones plus what we’re talking about from Avantis or DFA. Let’s go back and compare this to the S&P 500 and a total market fund. The S&P 500 is an index that takes the top 500 size companies and just arranges them in order by how how big they are. The total market fund, like a VTSX or VTI takes all the companies and does the same arrangement, but because of the waiting mechanism, they turn out to be almost the same thing. And although I know people say, well, the total market fund includes some smaller companies in it, it really doesn’t include any significant amount of smaller companies in it. It that’s why VTSAX and VOO perform almost the same way. If you asked me for cream in your coffee and I gave you one eye dropper of cream, you would not consider that to be cream in the coffee. That is about how much cream or small cap that VTSAX has in it. It’s not a meaningful amount. Mathematically, it’s just not a meaningful amount. And that is why those funds are way up in those large cap and large cap growth boxes. They’re way up high to the right. They’re not down below. So, if you want to add um more cream if you will, or more cowbell as I like to say sometimes, you would go down to these small cap value funds.
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Scott: The real question I’m asking is not that we should whether we should add cream to the coffee or not, it’s whether I should add half and half or hazelnut or whatever, right? And that that’s that’s what I’m trying to get to here, right? We hear AVUV coming up all the time in these conversations and I can’t explain why AVUV is different from another small cap value fund. I want a hazelnut coffee, that’s the one that’s going to taste really good. Why why is AVUV hazelnut and another fund, you know, half and half?
Guest: It’s all in the algorithm and let me explain. it’s because it’s using a different, slightly different index. So let’s let’s go to the the the classic three indexes that are used for small cap value. One is the Russell Index. Now when the Russell Index does small cap value, it is just looking at the size and just looking at the value growth component. and it’s the worst performer of the three common indices. The next one is the S&P 600 small cap value index. That not not only looks at small and value, it also has a profitability filter on it. So it excludes essentially companies that have not made a profit in the last couple of quarters. And so that that makes that index different from the Russell, which is the basic index, and that index tends to outperform because as you can imagine, if you remove a bunch of unprofitable companies from a group of companies, the remaining companies are going to perform better. Another indices and the one that was originally used by Vanguard and in the um, Fama French research is what it’s called the CRSP index. That one tends to be a little bit larger on the small and so it it kind of bleeds almost up into the midcaps and so it does have a different kind of performance because it’s more midcapish because they’ve changed the index as far as how big the companies are. That one also has a profitability filter on it. So those are the three basic indexes. Now what something like AVUV does is add more of a profitability or quality filter on top of this. So basically what it is doing is is looking at these small cap value companies and then getting rid of the worst ones essentially. And since it it’s in index or algorithm does a better job in getting rid of these worse companies, it has a better performance or has had a better performance for the past 30 years. AVUV itself is not that old of a fund, but it is based on a same kind of algorithm as an older fund that goes back to the 1990s. DFSVX or something like that. But anyway, that one goes back to 1993. AVUV is a similar fund to that and that’s why it seems to have these better uh performance characteristics, basically because it’s excluding bad companies.
Mindy: So, back on episode 659, you walked me through setting up a risk parity portfolio. Uh if you haven’t watched that, go back and watch it. It’s a really awesome episode. And you put me in AVUV and looking at my performance, that is the number two performer. Number one is gold and I keep selling gold to fund my withdrawals because it keeps going up.
Guest: Welcome to my world. What do you think I’ve been doing for the past three or four years?
Mindy: Gold is uh 19% of my portfolio, even though it’s only supposed to be 16% of my portfolio, and I keep selling it and it just keeps going up. But it we’re not talking about gold. And I think gold is an outlier. I think this is a weird time. But AVUV is up 23% since I bought it.
Guest: Yeah.
Mindy: Wow, Gold is up 50% since I bought it. Holy cow.
Guest: Yeah.
Mindy: Wow. I that’s not the column that I normally look at. So, AVUV sounds like an actively managed fund or at least more actively managed than a VTSAX. So, in the FI community, I keep hearing don’t invest in actively managed funds, invest in passively managed funds because your expense ratio is lower. But if the AVUV fund is outperforming at such a rate, it seems like it’s better to be in an actively managed fund sometimes. So how do you like tell the difference between when you should be in an actively managed fund and when you should be in a passively managed fund? For those of our listeners who are all index funds and they’re like VTSAX and forget about it.
Guest: Well, I think we need to get our definition straight because AVUV is not an actively managed fund.
Mindy: Oh, it’s not?
Scott: It is technically called an actively managed fund, but that’s not, that’s like not a reasonable way to describe it, right?
Guest: I would describe this as an algorithmic fund, which is the way I would describe all index funds. There are no people sitting around a table picking these stocks. It’s basically they’ve created an index of categorizations, they run a computer program on it and it picks the stocks for them. It works exactly like VTSAX or VOO, just using a different index or categorization method. There’s no magical people sitting there picking things and hoping to get lucky and maybe they’ll get lucky some times or not. I I view them as an index fund. The distinction you really need to draw when you’re looking at something like this is, do we have people around a table picking stocks and putting them into this fund? That is an actively managed fund. That’s human management. What we’re talking about here is an algorithm run by a computer. It’s the difference between somebody pushing a broom and a roomba.
Mindy: Well, that’s a great analogy. I like that a lot. So, what is the expense ratio for AVUV? Do you know off the top of your head?
Guest: Yeah, it’s about 0.2 or 0.25, somewhere around there. And I would not compare that to something like VTSAX, I would more compare it to those three basic small cap value funds that I talked about. So the the Russell IWN fund typically performs like 2% worse than something like AVUV. You are getting more bang for your buck and this is why people were willing to pay financial advisors for this. It wasn’t cheap to go to Paul Merriman’s firm and get DFA funds back in the day. You were paying 1% to Paul Merriman’s firm and you were paying more than that just to get access to this fund because it was that much better. So the way you should look at it is, you don’t have to pay over 1% uh to get access to a fund like this. You’re now paying 0.2% and so you’re getting even more than you would have back in 2010 when uh this became a popular thing amongst financial advisors.
Mindy: I like that you explained that because you might not compare it this this 0.2 or 0.25 to VTSAX, but I’ve got listeners who will. and I like that you explained, you’re getting a better return. Past performance is not indicative of future gains. This is not financial advice. Blah, blah, blah, the disclaimers, but AVUV is my second highest performer. Now, I’m going to go back into my other investments and look and see where I can maybe make some tweaks to include AVUV in other portfolios that I have. This is it’s the only one I have it in right now is my Frank Economics portfolio that you helped me set up.
Guest: I would not compare it for for just six months though. I would go back and you can you can find the DFA small cap value fund that goes back to 1993, and if you compare that to the S&P 500 or VTSAX, you’ll see that that fund has outperformed since that time, actually, since the beginning of the millennium, but they perform differently at different times. So if you looked at say the past 10 or 15 years, the large cap funds have outperformed. They’ve done much better. Large cap growth has been the place to be, but if you go back to the early 2000s, those big companies, you know, crashed, you know, 40%, 50% between 2000 and 2003 and your small cap value companies were either going up or flat at that time.
Mindy: Yeah, I remember that crash.
Guest: Same thing happened in in 2022. I think AVUV was down 5% where the S&P 500 was down 25% or something like that. That’s really what we’re talking about here. We’re not looking really for what do we think’s going to outperform in the near future or something like that. What we really care about is is this going to perform at least as well as the rest of the stock market and is it going to perform differently than something else I have because that’s that’s the reason to hold more than one thing when it comes down to it.
Scott: Frank if I if I’m thinking about small cap value, right, like I I can’t help but kind of just conjecture, like this is how I work on all of my life, right? What does fictional perfection potentially look like and then how do I refine that hypothesis based on additional assumptions, right? So if I’m thinking about a small cap value fund that to me intuitively would perform really well with reasonably stable returns, I think about first of course, price to earnings ratios. I’d think about a certain size dynamic. I’d think about, you know, no extreme leverage, right? You could have a great price earnings ratio, but if you have 20 times your earnings in debt, that’s not a good sign. That’s not really the thesis that we’re betting on. If you have a some kind of recurring revenue and your deferred revenue balance is falling dramatically or, you know, that that is different than a company that is growing deferred revenue very rapidly, which is almost certain to hit the price earnings multiple downstream, right? Growth profiles or the amount of capital intensity of the business is going to make a make a difference as well. Those are some of the dynamics. We can argue about some of them, maybe extreme leverage should be included because on average it amplifies returns, right? There there’s an argument there, but those are like the the starting points I’d have for small cap value and what I what I would be intuitively thinking I’m investing in. Can you reassure me that that funds like an AVUV have some of those components in place even if they disagree with the premise potentially of some of some of the other ones that I just stated?
Guest: Yeah, I mean and and you can and should look at the components of whatever fund you’re investing in. If you go to a place like Morningstar, it’s the easiest place to get a feel, that you put your fund in there and then click on the portfolio thing and it gives you all these data points including the top 25 companies in the fund and then it also gives you the sector breakdown so you’ll find that small cap value has a lot of financials in it, which are essentially small banks and insurance companies and things like that and other, you know, small manufacturers and industrial companies.
Scott: It’s the kind of businesses that, you know, Cody Sanchez and Alex Hormozi talk about buying, right? Like the HVAC business.
Guest: Yeah, storage facilities and dry cleaner type.
Scott: Yeah. what they don’t tell you about the HVAC and the garage door business is is how hot and cold or up and down it can get. That’s the kind of stuff that they’re they’re going for.
Guest: That’s the sort of thing and and they’re are usually a couple of thousand companies in each one of these funds. So it’s they’re really well diversified. In some respects, they’re they’re much more better diversified than like a VTSAX or a S&P 500 because they don’t have the same kind of concentration. If you look at the top 25 companies in the small cap value fund, that’s not going to be, uh, you know, 80% of the fund. Whereas if you look at VTSAX right now, I think the top seven or 10 companies are like 40% of the fund. So it’s actually more diversified when you get to these smaller funds then a large cap fund.
Mindy: Can you explain why VTSAX has those top companies taking up 40% of the fund?
Guest: It’s all in the algorithm. The algorithm used for VTSAX tells you to take all the companies, but then arrange them by size and put more money in the biggest ones. The bigger they are, the more you own of it as certain things become bigger, you buy more of it. in a sense it’s kind of a a momentum fund. the better something is doing. that’s why an video went from a very small part of VTX to now, I don’t know, maybe it’s the largest company in there. I I don’t know. Uh it’s close to it. But that’s why you get this big concentration at the top and that’s also why all of these large cap funds tend to be the same. They’re all investing in the same things and in large proportions. So whether you took a an S&P 500 fund or a large cap growth fund or VTSAX, there’s a huge overlap there. They’re they’re basically investing largely in the same things, but it all has to do with the algorithm again that is used to set up the fund.
Scott: This is kind of a tangent here, but one of the things that I’ve been very worried about, you will be, I’m sure push back on this, but I think that that concentration in the S&P 500 or in any any major index around market cap waiting is especially dangerous right now because of the AI dynamics. When we talk about like for example in 2026, there’s an estimated $600 billion that’s going to be invested in AI specifically, most of that in chips. Those chips depreciate essentially become obsolete after about 18 to 24 months as the next generation cycles through. So that’s capitalized and does not get off does not offset earnings for these companies in that year and it’s depreciated over five or six years. However, I believe that realistically, 80 to 85% of that spend should be expensed in the in the year. That changes the forward price to earnings multiple or the past price earnings multiple pretty dramatically. that single change in terms of how you view how you think the accounting should treat AI investment in the markets here. This is a tangent again, but any any reaction to that observation at a high level from from your view in terms of how that that would change or tweak or influence anything related to investing?
Guest: Well I think if you look at the the history of stock market and see how this this goes, I mean, there are parallel. We’ve seen this kind of a movie before and it generally occurs when the stock market has been doing well over a long period of time and that is often connected to some kind of new technology, whether it’s railroads or the internet or something else. What happens is the largest companies grow a lot. People get excited about them, they put more into them. That increases the concentration at the upper ends of these index funds, these large cap index funds that are cap weighted. And so then sometimes it crashes. I mean, I don’t have any disagreement with what you said technically, but I’m just telling you sort of my view of this is, you know, this movie has happened before and we know, we know how it ends, but it doesn’t necessarily end that way. But let”s think about what if it does end badly? because this happened in the early 1970s there was something called the nifty 50, Xerox, Polaroid. that was a time when everybody was saying, these 50 companies are the are the bees knees and just put your money into them. Don’t worry about the valuations, you can’t lose. And people did lose. The major consequence in the 1970s, the reason the stock market stayed down as long as it did was because these nifty 50 companies crashed and didn’t recover. The same thing happened in the dotcom era. So you had all of these, uh, companies, fortunately the ones today, the the difference people point out today is well they’re at least they’re profitable today. The ones we’re talking about in the 1990s weren’t profitable and people were throwing all kinds of money into them. But you got the same results. these things grew up, they got really big and and then there then there was a crash. In both cases, holding value stocks saved you. That’s the lesson. that if you held value stocks in the 1970s, small cap value or even large cap value, the small cap value companies went up every year from 1975 to 1987 while these large cap nifty 50s were, you know, down in the dumps and having all kinds of problems. Same thing happened in the early 2000s, the total market indexes and the big tech companies and everything crashed and went the Nasdaq node went down 80% and the S&P 500 went down 40 or 50%. Uh if you had value companies, they either didn’t go down much or they actually went up. The lesson here is not to worry about trying to forecast this or is this like before or is this not like before. I would rather say, I don’t know, but I won’t put all my my eggs in that basket. I will put some of my eggs in this value basket because I know that if that crashes, this one’s probably going to do a lot better and I’m going to be better overall and I’ll be a lot safer and happier.
Scott: I love it. I find this so fascinating because, you know, I I just invested in the S&P 500 for, I don’t know, 10, 12, 15 years as my only stock exposure essentially for the entirety of my accumulation phase and only really thought about this towards the very end when I was transitioning to be like, okay, I’m going to actually start living off a little bit of the portfolio that I’ve built here now. This discussion, I think if I had understood all of this when I started, I would have almost certainly mixed it up and had some, you know, S&P 500, some value component to my growth portfolio, and then maybe some international split between those two as well, between international blend and international value, as well in there, but at least those two dynamics in that growth journey. And the irony there is that if I had if I had known this and done that, I’d be less wealthy than I am today because small cap value underperformed the S&P 500 during that time horizon, right? And like that’s the fun thing about investing here is like the more you like you can know all this extra stuff and get get more sophisticated and then it’s like even worse than the other alternatives because it’s just so unpredictable.
Guest: You can only know in hindsight what was the best combination of funds to hold in the last period. The key is is just let’s invest in low-cost funds that are 100% in equities when we’re accumulating and just keep putting in money and figure the rest of this out later because it it doesn’t matter as much until you’re pulling money out. And you can’t predict which combination of a few index funds is going to be better than another one in the next 10 or 20 years. you just can’t. so the key there is is just don’t put your money in target date funds. they have bonds and other weird things in them. Just get your index funds and put your money in there and then leave it alone. There is a convenience factor Scott in terms of yeah, if you would have known this, you know, 20 years ago and you did half small cap value and half large cap growth or something like that, then it would have been easier to transition into a diversified retirement portfolio. But not doing that doesn’t kill you that much, particularly since a lot of people have these things in the retirement accounts anyway and there’s no taxes and you can just sell one thing and buy another one.
Scott: That’s right. If my gains had been smaller, I’d pay less taxes, Frank, you’re absolutely right.
Mindy: I need a Delorean with a flux capacitor.
Scott: I guess this leads to the next question, right? Like, you know, the coffee is, you know, the S&P 500, right? That’s your black coffee. You got to mix in the creamer, which is going to be your value. The right creamer makes a big difference and if you’re not putting hazelnut in your coffee, you’re you’re you’re doing it wrong metaphorically here. So does it is that written play to the next discussion ought to be what how how we uh sweeten the coffee uh in terms of like Stevie or sugar or one of these these uh sweetener alternatives and that’s where international comes in? Or am I reaching way too far now into our coffee analogy?
Guest: You’re probably racing too far into the coffee analogy.
Mindy: My international has been good, but not as good as gold. So sweeten it with gold, Scott.
Guest: Well, gold is an international asset too. That’s the reason.
Mindy: Oh, ah, okay. I don’t even think of it as domestic and international. I’m, you know, Frank, Americans just think everything is about them.
Guest: It’s a good thing my father’s from another country. The international that you put me in is also Avantis.
Guest: Yeah, well, they that’s because you can um now buy small cap value in the international flavor or uh large cap growth in an international flavor. That’s what’s so nice and what what has developed over the past eight years or not. These things were hard to find and they probably cost a lot more money than they do now. But um now that we do have DFA and Avantis both putting out reasonably priced ETFs that cover these different asset classes or subclasses is really what they are. There’s a lot more choices that we have. and and you know, 20 years ago we didn’t we didn’t have these choices. We just you had to pay an advisor to get even close to access to them. So, we we need to take advantage of the modern iPhone here and go out there and take a look at these things. You know, and then you mentioned Paul Merriman, he’s got his little team there and they actually review all of these funds and and do a categorization and they publish it on their website saying these are the best in class. If you’re looking for an international small cap value, try one of these. Um if you’re looking for US small cap value or large cap value, try this one. In a sense, if you’re just looking for a fund, they’ve done that work for you. That’s where I would go if somebody says, I want a midcap growth fund and I’d go in there and say which ones look good because they’ll list all the basic index funds plus some of these more advanced things.
Scott: I want to summarize kind of where I’m at here, right? We we have great research that discusses the advantages of splitting a portfolio out like this and in essence waiting much more heavily than a broad-based market cap weighted index fund would to small cap value. So that’s that’s the first pillar here. The second is that there are varying degrees of complexity about how to wait to small cap value and we have from the from the very simplistic in the in in in the Russell, you know, 2000 or the the S&P 600 small cap index, and to increasing levels of sophistication um with some of these more these more algorithmic funds here. I still don’t think we know exactly what the thesis is for AVV specifically. There may even be a proprietary element to it. It was not available in a way I could understand very clearly like what those hard rules are on the मॉर्निंग स्टार वेबसाइट. I did actually looked that up before our our call here. and I can’t really find I could I still can’t explain why it’s different than a very close peer fundamentally, even though I know I have seen Paul Merriman site say, hey, here’s the edge here. It’s very close between these two, but I we prefer this one for this reason. And so I think that’s kind of the next layer of depth I would I would love to get to over time is like, no, no, actually specifically, what is it that AVUV is doing? I think that’s the third leg of this conversation um or this study that I’ll have to do in the in the coming weeks here to say, no, that’s exactly what these are the rules that you’re investing in and here’s where you can debate with them, you know I think reasonable people can disagree on where certain cutoffs should be in value, but those will matter over time. Those will separate performance across these these funds in ways you probably can’t predict. Is that the right takeaway to have from today’s conversation, Frank?
Guest: Well, if you want to do that research, you can do it and that’s what Paul Merriman and his team have done. If you go to some place like portfolio visualizer, there is an analyzer that will break funds down by how big or small they are, how value are they, how much momentum they have in them. They will basically categorize them by factor and so you can look and see which of the small cap value funds is the most valuey or the smallest, or has these other characteristics. Um and so you can do that research and see some of that. What you can’t see is the kind of profitability or quality factor that AVUV or DFA is actually applying because that is the their proprietary way of constructing the fund. But they do describe that in the text if you look at the prospectus basically, we’re taking the basic small cap value and then applying these other filters to get essentially get rid of bad companies. Is basically what’s going on there. So it’s not it’s not magical, but it’s not no, they’re you you cannot find the AVV index posted somewhere.
Scott: Fair enough, yeah.
Guest: Because then Vanguard could create one.
Scott: Frank, this has been absolutely phenomenal and very educational as always here. Uh I have one last question before we go, which is how do you like your coffee?
Guest: Black.
Scott: Me too. Yeah. Same here. So
Mindy: Wait, I thought you liked it with hazelnut. I was gonna say, Scott, you’re doing it right. You’re both doing it wrong.
Scott: W once in a blue moon, I’ll put some hazelnut creamer in there, but no, I I I mostly drink it black.
Guest: I will have a cappuccino like when I’m on vacation or something, but on a day-to-day basis, you know, I’m a black coffee chugger.
Scott: I do put a little bit of cinnamon on the top of the beans and that adds a nice little spice to the coffee, just a little bit. That’s a pretty nice touch if if you’ve never tried that.
Guest: That sounds wonderful.
Scott: Well, hey, thank you so much for for coming on today. uh coming back on again, Frank, really appreciate it and uh yeah, can you can you remind everybody where people can find out more about you?
Guest: Oh, yes. I run a podcast called Risk Parity Radio. They’re all find their podcasts are sold plus we have a website and I had a volunteer nicely fix the website so it’s now actually searchable for stuff like this if you want to go in there and find because there’s 500 episodes or almost 500 episodes of the podcast. I do want to plug uh my podcast is a retirement hobby and it’s not for profit, but we do raise money for charities and we usually raise money for my charity which is called the Father Centra, but starting tomorrow and and the next couple of months, we are raising money for my wife’s charity because she reads the emails and she works for Fairfax Casa, which is court-appointed special advocates. So these are volunteers who assist with children who have been removed from the home and they’re in a foster situation until they go through the court process and uh figure out whether they’re going back to their parents or getting adopted or something else like that.
Scott: What are the two web URLs or best ways that people can remember to donate to one or both of these charities?
Guest: I put this in the show notes at my podcast and it’s going to be on the support page. I think that’s the easiest place for somebody to look, but uh it’s Fairfax County court appointed special advocates, that’s a mouthful in Virginia is is hers and uh the Father Center, M C K E N N A in Washington DC is the is the one that I’m affiliated with.
Scott: Awesome. People should go and check out your show if for some if many people will not may not will not take all that step. We will link to both of those in the show notes here.
Guest: And you can Google them.
Scott: Just so you know that you’re aware, even if you don’t actually go on to listen to Frank show, which you should to find those charities. It’s great work that you’re doing um there and thank you for for all you’re doing for the personal finance community and for the the folks in your in your community locally.
Guest: Well, thank you. I I enjoy this.
Mindy: Frank, it was great to talk to you. Thank you so much for your time and we’ll talk to you soon.
Guest: Okay, great.
Mindy: All right, Scott, that was Frank Vasquez and I mean, what do we say to follow up Frank? You knows everything. Go listen to his podcast and contribute to his charities.
Scott: I think the answer is that Frank is a real master on these macro allocation theory items here. And, you know, alongside folks like Paul Merriman. And we still don’t really know what it is specifically that differentiates AVV from its peer set and its alternatives in there and there’s a little bit of a a trus implication in there if if that’s a specific ETF. so I don’t think we can specifically recommend AVV. um and I think we can only specifically recommend going down this rabbit hole of understanding why folks argue for small cap value and then how to define it and how to add it to your portfolio for the reasons that makes sense to you. So that’s a rabbit hole I want to continue to go down. I am a nerd. I want to understand at the mechanical level everything that I’m putting my money into. and I still don’t right now um when it comes to AVV even if I some to some degree implicitly trust the the the research that backs small cap value in the first place.
Mindy: I have AVUV in one of my portfolios, in my Frank Economics portfolio and I like the way it’s been performing. So yeah, it’s time for a deeper dive into past performance, which is not indicative of future gain, blah, blah, blah. But past performance is a good place to look. It’s a good place to start. So I am going to dive down that rabbit hole and maybe start making some more allocations. But yes, this is not financial advice. This is just information so you can do with it as you please. Thank you for listening. All right, Scott, should we get out of here?
Scott: Let’s do it.
Mindy: That wraps up this episode of the Bigger Pockets Money podcast. He is Scott Trench. I am Mindy Jensen saying see you Chia.
Scott: See you later. Late.
Mindy: see you later Late.
Scott: See you later. No, see you Chia.
Guest: Oh.
Mindy: That was really cute. Yes, but we’ll also see you latte. If you put hazelnut in it, Scott, if you don’t put hazelnut in it, you’re just wrong.
Scott: That’s right.
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