Do I Need VISVX When I Own VTMSX?

Unlike our taxable investments which consist of quite a large number of mutual funds, ETFs, and stocks, I try to maintain a small number of funds in our IRA accounts and use mostly Vanguard index funds to keep the expenses low. Among the total of 10 funds in our IRA investments, we own Vanguard Total Stock Market Index (VTSMX) and Vanguard Small-Cap Value Index (VISVX).

As John Bogel, founder of Vanguard, said in his book The Little Book of Common Sense Investing* that the best way to invest in the US stock market is to own the entire market and hold it forever. If VTSMX already covers the entire domestic equity market, why bother adding VISVX to the mix? The reason for having both VTSMX and VISVX in the portfolio is not for diversification, but for asset allocation, which can be explained by the asset allocations of these two funds:

Since VTSMX has 72% of its assets invested in large-cap companies, having a single fund doesn’t give me the enough exposure to small- and mid-cap stocks, which have been outperforming large-cap stocks for quite some time. Historically, small-cap stocks returned more than 2 percentage points higher than large-cap did. Thus, I want to have a larger portion of our investments in small-cap companies in an attempt to boost the overall return. Adding VISVX can give me just what I want, though it means overlaps between these two funds.

Using Morningstar’s Instant X-Ray, if I mix VTSMX and VISVX at a 4:1 ratio, the combined asset allocation becomes

Now the large-cap is only about 58% of the total investment, with mid- and small-cap going up to 42%. To me, this allocation is better than what I would have if investing entirely with VTSMX.

I applied the same approach to my 401(k) plan, where I have Fidelity Freedom 2035 as core holding and a small portion (15%) of Fidelity Small-Cap Value Fund to add small-cap exposure.

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