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:

visvx_vtmsx_asset_allocation.png

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

combined.png

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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8 Responses to “Do I Need VISVX When I Own VTMSX?”

  1. Luke |  Jul 31, 2007 at 9:17 pm

    Hey there…I caught this link over at genxfinance…Nice site!

    I have both VISVX and VTSMX [contained in my Vanguard 2045 fund, which is like 70% of that fund]…

    I am around 19% with VISVX and 20% with VTSMX…I think there is a nice balance to having the total market as a core fund and then also over-lapping in a sense with mid-caps and small-caps…

    I personally look at, with my younger age, VTSMX as almost a safe core investment and then from there I build riskier stuff around it…IMHO, VTSMX and other target funds are rather conservative…

    Your 4:1 ratio seems about right for US coverage…I have other funds that bring me up with the large-caps like VEIPX among others…

    I personally like at minimum, 10% in small caps….and might I add…If you got some money now, its a GREAT time to go shopping with the sale we got going on…

    Look forward to coming back…I got ya bookmarked…

  2. John |  Jul 31, 2007 at 10:59 pm

    Sun,
    Just curious if you have any International funds in your IRA. With the US growth slowing; it would not be a bad idea to explore emerging economies even in your IRA.

  3. Matt |  Aug 01, 2007 at 11:14 am

    I support small cap tilting to enhance performance. While this will also increase risk, it should increase long-term perforance. You just need to be able to stay the course during times like the late 90s when large caps outperformed.

  4. Sun |  Aug 01, 2007 at 11:01 pm

    I use VTMSX as the core holding in my IRA account. Since the fund covers the entire US stock market, we can expect to get average return from the fund. Nothing spectacular. In some sense, VTMSX is quite conservative since the returns from different sectors are evened out. Adding VISVX is just to squeeze out a little bit more returns. I like small-cap funds, so I want a little bit larger percentage in small-caps. In addition, I also have VGTSX, the international index, and TIPS (VIPSX) and bonds (VBIIX). These funds give me the coverage of stocks (domestic and international) and bonds (long and intermediate).