Don’t Let Your Investments Drift Away, Ep #173

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

Outline of This Episode

• [1:09] My summer working in Alaska
• [5:40] Why I prefer mutual funds and ETF’s
• [9:24] You want allocations in every major asset class
• [10:21] Using the small-value asset class as an example
• [19:43] Do not 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—do not 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 was not 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 is 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 did not belong there. That’s a problem! If you want small-value, it is now drifting away from where it should be. Why is it a problem? You are not capturing everything value has to offer.

Invest in a different management strategy

If you have 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 do not reconstitute, it is 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 its teeth once a year. At Dimensional Funds, if a company like GameStop moves from small-value to growth, it can be removed. These funds do not 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 do not know when it will show up. So when you do not rebalance frequently, it can reduce the likelihood that you will 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 does not 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!

Resources Mentioned

• The Center for Research in Security Prices
• Dimensional Fund Advisors

Connect With Scott Wellens

• Schedule a discovery call with Scott
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• Visit Fortress Planning Group
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• Fortress Planning Group on Facebook

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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.

About the author, Scott Wellens

Scott Wellens, CFP® is an investment advisor and founder of Fortress Planning Group. After earning his Bachelor of Science degree from the University of Wisconsin-Oshkosh, Scott quickly ascended to become a Vice President of North American Sales at a major regional provider of telecommunications infrastructure. While financially successful in this role, Scott searched for ways to pursue his passion related to financial literacy and providing financial freedom for both his own family and others. During his search, Scott became curious about the significant gap he found in the financial services sector: he was unable to find a comprehensive financial planner that maintained a family stewardship lens without being attached to financial products. Scott decided to fill that gap by creating his own planning firm that maintains a strong passion for comprehensive, unbiased wealth planning that is genuinely client-centered.

Scott resides in Menomonee Falls, WI with his family. He is the father of three active and independent daughters who keep him on his toes. Scott is an active community member, serving on the Hamilton Education Foundation Board, serves as a Dave Ramsey Financial Peace facilitator and leads the All Pro Dad’s group at their local elementary school. Scott enjoys spending his free time visiting state parks with his family, reading, and watching the Milwaukee Bucks and the Green Bay Packers win ball games.

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