Opinion: Making this small investment change can mean millions more in retirement

This time of year is filled with “best of” lists: movies, books, restaurants, electronics, toys, and more.

I have only one item in my list.

The best investment lessons for 2022 apply to nearly every investor. You should hold at least a few percent of your portfolio in funds that own small-cap value stocks.

It doesn’t have to be a lot. As we will see, given enough time, even a small percentage of small-cap value holdings can make a huge difference.

This lesson itself is not new. I probably wrote at least 20 articles and co-authored an entire book aimed at pointing out the long-term benefits of small value stocks.

New is a table of data to highlight my point.

As you probably know, small cap value stocks represent ownership of smaller companies with relatively cheap stock prices for a variety of reasons.

“Small” in small-cap value means you’re buying a company with huge growth potential. If you own hundreds or thousands of these companies through your funds, you are almost certainly on the ‘ground floor’ of what could be Microsoft MSFT.
Apple AAPL,
or Amazon AMZN,
for the next decade.

“Value” in small-cap value means you’re buying these stocks at a discount based on earnings measured by price-to-earnings ratios. That’s the smart way to invest.

Over the past decade or so, I’ve become convinced that simple portfolios are more likely to succeed than complex portfolios, at least for most people.

Luckily, it’s easy to add small-cap value to almost any portfolio. Over time, the rewards for doing so can be substantial without adding significant risk. is not.

To illustrate this lesson, I’ve put together a simple table showing the long-term historical impact of adding various percentages of US small caps to the S&P 500 index SPX.

The numbers are based on calendar years 1970 to 2021, a relatively long period that includes all kinds of ups and downs in the economy and markets.

For each combination, the annualized return and three measures of standard deviation, maximum drawdown (percentage of decline from peak to subsequent trough), and worst 12-month risk are shown in the table.

small cap value percent






annual return






standard deviation






worst 12 months






worst drawdown






Source: Merriman Financial Education Foundation

As we discussed in a previous article, an extra return of just 0.5 percent can be up to $1 million or more over a lifetime in retirement withdrawals and money you can leave to your heirs.

Adding just 10% of small-cap value to the S&P 500 portfolio is almost achieved, adding 0.4 percentage points to returns. Still, the risks are about the same. Boosting the S&P 500 at a 20% value for small caps doubles the additional benefits, but carries so little additional risk that most investors probably won’t notice.

I used the S&P 500 as my base portfolio, mainly because it is familiar and easy to understand. I also believe that most investors’ stock portfolios at least roughly replicate the US large cap index.

But you can add small-cap value to your other investment mix. Based on everything I know about the past, doing so can increase long-term returns without adding much risk.

So far, we’ve discussed the benefits of adding small-cap value only in terms of higher returns. These higher returns mean more money to spend in retirement.

But my friend and colleague, Chris Pedersen, director of research at the Merriman Foundation for Financial Education, concluded that these higher expected returns could offer additional benefits.

This is a double advantage. Higher percentages apply to higher portfolio balances.

To see how this works, consider the following hypothetical scenario.

You and your friend each invest $500 each month in retirement accounts for 35 years. Your friend’s money is 100% at S&P 500. Your investment will be allocated 80% to the S&P 500 and 20% to small caps.

After 35 years you and your friends are ready to retire. Based on the past annual returns in Table 1, your friend’s account is worth $2.46 million. Your value is $3.05 million.

With a 4% withdrawal rate, your friend can spend $98,565 in his first year of retirement. You have $121,904.

That’s a pretty nice bonus, and knowing you can always pick up the check when the two of you go out to dinner, you can stop there.

But there are more. Even if he (wisely) added a bond fund in retirement, if he continued to invest his 20% of his holdings in small caps, his expected return in retirement would still be high.

This higher return gives us $137,142 if we decide that we can safely increase withdrawals to 4.5%. That’s 51% more than my friend’s first year payment.

For most investors, we believe the large additional rewards are worth the relatively modest increase in risk.

For those readers who want to delve deeper into this entire topic, we recorded a podcast: 10 Reasons Why Small Cap Value Will Make You Rich.

Richard Buck contributed to this article.

Paul Merriman and Richard Bach We are talking about millions! 12 easy ways to improve your retirement life. Get your free copy.

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