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Don’t Let Your Investments Drift Away, Ep #173
Episode 1739th July 2021 • Best In Wealth Podcast • Scott Wellens
00:00:00 00:22:28

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What is style drift? Style drift is when the fund you’re invested in drifts away from its investment objective. Why is this problematic? How can it impact your portfolio if your mutual fund isn’t actively managed? In this episode of Best in Wealth, I’ll share more about style drift, give an example of what it looks like, and I’ll tell you one of the best ways to avoid it. Check it out!

[bctt tweet="Don’t let your investments “drift” away! Find out what I mean in this episode of Best in Wealth. #wealth #retirement #investing #PersonalFinance #FinancialPlanning #RetirementPlanning #WealthManagement" username=""]

Outline of This Episode

  • [1:09] My summer working in Alaska
  • [5:40] Why I prefer mutual funds and ETFs
  • [9:24] You want allocations in every major asset class
  • [10:21] Using the small-value asset class as an example
  • [19:43] Don’t let a huge drift impact your portfolio

Why I prefer mutual funds and ETFs

After I got my Bachelor’s degree, I took a lot of classes on investing to learn how to buy/sell stocks. After all of that, I realized that traditional active management is probably not the right method for a family steward. Why? When I look at The Center for Research in Security Prices, I see that the smartest people—who are being paid millions—don’t do very well. Only 20–25% actually beat the market—and the odds only get worse over a 15-year timeframe. I knew traditional active management wasn’t for me, so I turned to index funds.

An index fund replicates an index (like the S&P 500). An index is not an investment, it’s simply a benchmark to use to compare investments. The S&P has several indexes, with the S&P 500 looking at the largest 500 companies. Russell is another company that builds indexes (i.e. the Russell 2000 looks at the 2,000 smallest companies).

Listen to hear why I think you need allocations in every major asset class!

Using the small-value asset class as an example

Small-value has been on a tear for 9 months. When that happens, you want to capture everything it has to offer, right? AMC and GameStop are priced squarely in the large-cap growth space, yet represented 2% of the Russell 2000 value index (as of May 31st, 2021). How can that be? Investors tracking the Russell 2000 value index may be surprised to learn that the list of holdings inconsistent with the index’s definition goes much deeper.

At the end of June, Russell does an “annual reconstitution.” That means that the companies that no longer fit the “style box” of that index are removed. Then it brings other companies in. What’s the issue with that? They only do it once per year. Since June 30th of 2020, a lot of things have happened. As of May 31st, 2021, 16% of the index’s weight was accounted for by stocks that didn’t belong there. That’s a problem! If you want small-value, it’s now drifting away from where it should be. Why is it a problem? You aren’t capturing everything value has to offer.

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Invest in a different management strategy

If you’ve listened to me for a while, you know I like companies like Dimensional Fund Advisors. Why? They have a small-value fund that is reconstituted as often as possible. When you don’t, it’s like brushing your teeth once a year for 24-hours straight instead of doing it twice a day every day for 2 minutes. A straight index fund is only brushing their teeth once a year. If a company like GameStop moves from small-value to growth, it can be removed. These funds don’t have to wait until the scheduled yearly reconstitution day.

Research tells us that the performance of small-cap value tends to be delivered by a small subset of the asset class. You don’t know when it will show up. So when you don’t rebalance frequently, it can reduce the likelihood that you’ll be holding the right companies at the right time when the premium comes in. The fix? Daily portfolio management.

The Russell 2000 Value year-to-date is up 27.47%—awesome, right? The DFA Small Value is up 35.35%, in part, because of daily portfolio management. That doesn’t even mean rebalancing every single day. If you can rebalance portfolios incrementally and keep the fund focused on the target asset allocation, you can be in the best position to capture exactly what the market has to offer. Listen to the whole episode to learn more about style drift and how to prevent it!

[bctt tweet="Why do you want to invest in mutual funds that are actively managed? I share my thoughts (and some research) in this episode of Best in Wealth! #wealth #retirement #investing #PersonalFinance #FinancialPlanning #RetirementPlanning #WealthManagement" username=""]

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Podcast Disclaimer:

The Best In Wealth Podcast is hosted by Scott Wellens. Scott Wellens is the principal at Fortress Planning Group. Fortress Planning Group is a registered investment advisory firm regulated by the Securities Act of Wisconsin in accordance and compliance with securities laws and regulations. Fortress Planning Group does not render or offer to render personalized investment or tax advice through the Best In Wealth Podcast. The information provided is for informational purposes only and does not constitute financial, tax, investment or legal advice.