Outside the Box: 5 great equity strategies over the past 94 years

This spring, my team at the Merriman Financial Education Foundation produced a new tool that uses a quilt-like colored chart to help investors make better decisions by comparing five simple equity strategies.

For every calendar year from 1928 through 2021, you can see at a glance how each of the five strategies did in relation to one other, along with their returns for the year. The colored boxes make it easy to comprehend a lot of information on one sheet of paper — or just one computer screen.

Here’s why this matters: In 1999, after the S&P 500 index SPX, -0.07% had appreciated by 17% over 25 years, many investors decided that index was all they needed to capture the gains from this roster of known and respected companies.

However, by then many academics were teaching (and I was preaching) the merits of diversifying into other types of stocks (asset classes) with favorable long-term returns — and which went up and down at different times and different rates than the S&P 500.

On the chart, you’ll see green boxes for the S&P 500, representing large-cap blend stocks, a mix of mostly growth stocks and some value stocks.

The pink boxes (labeled “US4F”) represent a four-fund strategy made up of equal parts of the four major U.S. asset classes: the S&P 500, large-cap value stocks, small-cap blend stocks and small-cap value stocks.

In a box in the lower right-hand corner of the chart, you can see that this combination had a considerably higher long-term compound annual growth rate (12%) than the 10.2% of the S&P 500.   

Perhaps the most interesting of these five strategies (“US2F” and orange) is a combination of two quite different asset classes: the S&P 500, dominated by the stocks of very large companies with popular stocks, and small-cap value stocks, representing small companies with relatively unknown and unpopular stocks.

In 67 of the 94 years in this study, one or the other of these two was the best performer while the other the worst. But when you put them together, the combination had a considerably better long-term return than the S&P 500, with much less volatility.    

That’s how smart diversification works: Peace of mind along with a piece of the action.

Here’s how I would evaluate this (orange) two-fund strategy:

Good: In many years, this did considerably better than average.

Not so good: This mix rarely resembled the reported swings in “the stock market.” In many years, its returns were lower than those of the S&P 500.

Bottom line: This is a good choice for investors seeking strong long-term returns, as long as they understand that most of the time, small-cap value stocks don’t go up and down in sync with the S&P 500.

Let’s look at the four other strategies in this chart.

The S&P 500 index (green) is the default for many people, and it’s much better than actively managed funds. (The total U.S. stock market index has similar long-term returns.)

Good: This index is dominated by large, familiar companies with good management. It’s how “the stock market” is commonly referred to in the news. In 36 of the 94 calendar years, this was the highest performer among the five strategies.

Not so good: Of the four major U.S. asset classes, this index has had the lowest long-term performance. In 48 of 94 calendar years, this was the weakest performer.

Bottom line: This is fine for investors willing to accept good (but not exceptional) long-term returns and who trust what Warren Buffett recommends for most investors (which isn’t the same as what he does with money he manages).

A four-fund combination of U.S. asset classes (pink boxes) includes every major part of the U.S. stock market.

Good: Over the long term, this delivers quite a bit more return than the S&P 500, with much less volatility.

Not so good: This strategy has almost never been the best performer.

Bottom line: I think this is an excellent choice for accumulators and retirees who want a better return than the S&P 500, without much drama.

Over the long haul, the two-fund value combination (orange boxes) of large-cap value and small-cap value has outperformed everything I’ve described so far.

Good: Performance, pure and simple, harnessing the power of stocks you can buy at bargain prices.

Not so good: Value stocks go in and out of favor. To get their long-term rewards, you absolutely have to stick with them during long periods of underperformance.

Bottom line: This is a good choice for aggressive investors who can tolerate risk and who want to emulate the way Warren Buffett manages money.

Finally, small-cap value by itself (“USSV” and blue) focuses on the single asset class with the highest long-term performance.

Good: A 1928-2021 compound annual growth rate of 13.4%.

Not so good: In 31 calendar years, or about a third of the time, small-cap value stocks were the worst performers.  

Bottom line: As a stand-alone strategy I think this is most appropriate for investors who are saving aggressively during their early working years.

I think there’s something here for everyone. If I were pressed to make a blanket recommendation from among these five strategies, I don’t think investors are likely to go far wrong with the four-fund U.S. portfolio (pink boxes).

For more on the history of these five strategies, check out my latest podcast.  

Richard Buck contributed to this article.

Paul Merriman and Richard Buck are the authors of We’re Talking Millions! 12 Simple Ways to Supercharge Your Retirement. Get your free copy.