Saving for retirement? These are the only two mutual funds you’ll ever need

Let’s face it, you’re probably reading this article because you want to make more money from your investments. This is the #1 motivation for investors.

So I’m going to tell you how to get some of the best long-term returns I know of with just two index funds, each tracking a well-known asset class with a very long track record.

Then I’ll show you how you can take advantage of many of these benefits in a way that’s likely to be a lot more convenient.

You’ll almost certainly want to add a fixed income fund or funds, but that’s a topic for another day. This discussion is about the equity portion of your portfolio.

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Highest returns

Based on data from 1970 to 2021 – a total of 52 years – two of the most productive asset classes were US large cap value stocks and US small cap value stocks.

During that period, a 50/50 combination of these two asset classes had a compound annual growth rate of 14.1%; now the S&P 500 SPX,
alone grew by 11.1%. Over that long period, the $10,000 in the S&P 500 grew to $2.3 million, versus nearly $9.5 million in the two-fund all-value combination.

In the 1970s, when the S&P 500 was growing just 5.8%, the all-value combo was growing 13%. As the S&P 500 struggled through two tough bear markets between 2000 and 2009, to lose At 0.9% annually, the all-value combination had an average growth rate of 8.4%.

However, 50 years is a very long time. I get it.

We calculated returns for all 15 years from 1928 to 2021. For all 80 of those periods, the average compound return for the S&P 500 was 10.7%. The average return for large-cap value was 12.8%; for small-cap value, it was 15.6%. When we calculated the numbers for average 40-year periods, the results were similar.

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Of course, I can’t tell you about future returns, but there’s every reason to think that value stocks will likely continue to outperform the S&P 500 over the long term.

To the best of my knowledge, the most money can be made in US value stocks without speculating or gambling. A good way to do this is with a 50/50 combination of small-cap value and large-cap value.

High return with more comfort

However, I suspect that most investors will reject this recommendation. After all, value stocks don’t have the buzz of big growth stocks like Microsoft MSFT,
Apple AAPL,
Amazon AMZN,
Facebook FB,
and Tesla TSLA,

Most investors don’t want their returns to differ too much from “the stock market,” which is commonly represented in the tabloids by the S&P 500.

Over the long term, some of the best returns in US stocks come from a relatively small number of large growth companies like those that dominate the S&P 500… and small-cap value stocks, as we saw above.

These are two very different asset classes. The S&P 500 is not for bargain hunters: Stocks in the index sell for about $20 for every dollar of current earnings. Small-cap value is a mecca for bargain hunters, with stocks costing around $12 for every dollar in current earnings.

So here’s a multi-million dollar idea for you: invest the equity portion of your portfolio in a combination of these two asset classes: small-cap value stocks AVUV,
and the S&P 500.

From 1970 through 2021, a portfolio split equally between the S&P 500 and small-cap value stocks would have experienced compound interest of 12.7% and nine calendar years of losses. For the S&P 500 alone, the compound return was 11.1%, with 10 years of losses.

This difference of 1.6 percentage points may not seem huge. But over a lifetime, a difference of just 0.5% can be worth more than $1 million in retirement payouts, plus what’s left to your heirs.

So I’m not kidding when I say this is a multi-million dollar idea.

If small-cap value stocks intrigue you with their returns and still feel a bit scary, you can allocate less than half of your stock portfolio to them.

We did the math annualized returns and other data for combinations of the S&P 500 and small-cap value stocks to show different outcomes, from dipping your toes in the water with just 10% small-cap value to a much more aggressive stance with 90% small-cap – Value . The data refer to the years 1970 to 2021.

Over those many years, each additional appreciation in small-cap value added 0.2 to 0.4 percentage points to long-term returns. Over a lifetime, every additional 10% of small-cap value could be worth hundreds of thousands of dollars.

A lot of people tell me they’re skeptical about value stocks these days. The reason isn’t hard to find: recent performance. From 2010 to 2021, the S&P 500 grew 15.1% and small-cap value stocks “only” 12.1%.

If recent relatively short-term performance is your preferred guide to the future, you don’t need the lessons of history.

However, if you’re willing to dig a little deeper, here are two interesting comparisons:

· Over the 25 years from 1975 to 1999, the S&P 500 had a compound annual growth rate of 17.2%. Meanwhile, an index of small-cap value stocks grew 22.3%.

· From 2000 to 2021, the S&P 500 is up 7.5%, small-cap value stocks are up 10.8%.

So why are small-cap value stocks so productive? Mainly because they are cheap to buy.

One of the most cited rules of investing is “buy low, sell high”. Small-cap value stocks are the way to do this.

Yes, it feels uncomfortable. But if you’re buying value stocks by the hundreds or thousands, as you can easily do with mutual funds and ETFs, that’s probably where the money is made.

For decades I have preached diversification based on long-term track records of relatively well-known asset classes. Both the S&P 500 and US small-cap value stocks certainly qualify.

I also preach moderation. For that reason, I think a combination of the S&P 500 and small-cap value stocks will likely be a winner for the equity portion of your portfolio.

more on this topic, Here’s a podcast I recorded.

Richard Buck contributed to this article.

Paul Merriman and Richard Buck are the authors of We’re talking millions! 12 easy ways to charge your Rretirement. Get your free copj. Saving for retirement? These are the only two mutual funds you’ll ever need

Brian Lowry

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