Is Smart Indexing A Good Investment Strategy?
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Is Smart Indexing A Good Investment Strategy?

Smart Indexing is becoming a more widely accepted investment strategy thanks to its intuitive philosophy of holding an equal exposure of sectors across the board. The status quo for benchmarking performance is to compare one’s equity returns to a broader index like the S&P 500. Because the S&P 500 is market capitalization weighted, exposure to certain sectors such as Technology after a bull run could pose risk to your portfolio. With Smart Indexing, the investor is constantly maintaining a more balanced exposure to equities.

Personal Capital supports the strategy of Smart Indexing because we believe it provides a better risk-adjusted return on investment. Unlike algorithmic money mangers who run investment portfolios through a machine to provide recommendations, Personal Capital employs a team of highly qualified individuals who help manage their client’s money through a multitude of life scenarios.

Let’s say you want to figure out the best way to save for your newborn’s college education. A Personal Capital advisor can help walk you through the steps and allocate your money appropriately. Let’s say you’re changing jobs and want advice on whether you should rollover your 401k, use the 401k for a downpayment on a house, or simply leave the plan as is. A Personal Capital advisor can highlight the pros and cons of each scenario. Or perhaps you’re retired after a fruitful 40-year career and would like to figure out the best investment strategy to make your money last a lifetime and leave some of your wealth to your grandkids. A Personal Advisor is there to structure your portfolio with various scenario outcomes to give you confidence that your goals are met.


Beyond the benefits of concierge financial service, I want to highlight the concept of Smart Indexing as used by the Personal Capital team to help clients improve financial returns. I sat down with Craig Birk, Executive VP of Portfolio Management and Kyle Ryan, Executive VP of our financial advisory team in San Francisco and Denver to learn more.

Imagine a scenario where you could reduce risk and volatility while increasing your returns over time. Such is the goal of Smart Indexing. For the US stock portion of portfolios, instead of following a market cap weighted approach to indexing like the S&P 500 index does, Smart Indexing strives to have a more balanced weighting across all sectors and styles. Let me focus on the sector part given it’s a little more intuitive and easier to understand.

The below chart demonstrates equal 10% weightings in 10 US sectors. If you were to follow the S&P 500 index as a benchmark for performance, you would be overweight Technology, Financials, and Health and significantly underweight Communication, Materials, and Utilities. You might think that being overweight Technology is a good idea because it’s a higher growth sector than say, the Utilities sector. However, you never know when the hot sector may turn cold.

Slide 1:

Smart Indexing By Sector

Take a look at the slide below to see what happened to the Technology sector from 1998-2002 and the Financial sector from 2004 to 2008. If your portfolio was market cap weighted with an estimated 29% weighting in Technology, your portfolio severely underperformed a Smart Indexed portfolio. The same goes for owning too much Financial stocks in 2006. The market has a great way of reverting to the mean. Smart Indexing also takes a more balanced approach to size (small, mid and large companies) and style (growth, core and value).

Slide 2:

Why Smart Indexing Is Good

You might now be wondering how does a Smart Indexed fund perform during a bull market? Shouldn’t one continue to press their momentum bets until something changes? After all, who wants to own sleepy Utility and Telecom stocks in a bull market when tech stocks continue to rip higher thanks to blockbuster acquisitions by Facebook and blazing IPOs like GrubHub? I wondered these same questions myself so I asked Kyle and Craig to show me evidence to the veracity of the Smart Indexing methodology.

The following slide shows two things: 1) Actual results between 9/30/11 to 12/31/13 of our Smart Indexed portfolio compared to the S&P 500 that produced 5.6% absolute outperformance with slightly lower volatility, and 2) Based on our backtesting of a $500,000 portfolio that began in 1990, one would have $1,576,588 more in their portfolio using a Smart Indexing approach vs. a market cap weighted approached. I don’t know about you, but there are a lot of nice things and experiences I could buy with an extra million and a half dollars.

Proof That Smart Indexing Works


Smart Indexing is a good alternative to just blindly following the S&P 500 index as a benchmark for exposure to stocks. Until coming to Personal Capital, I never once questioned why following the broadest market index might not be the optimal benchmark due to group think. Everybody does it, so why change?

Now that I understand the merits of Smart Indexing, I believe there are three main reasons why more people don’t employ the Smart Indexing strategy:

1) People don’t know that such a strategy exists.

2) People don’t have time to constantly monitor and rebalance their portfolios.

3) People think they know more about the future than they really do.

Now that you’ve read this article about Smart Indexing, you can cross #1 off the list. You should also cross #3 off the list because we all know you can’t beat the market over the long run by stock picking or jumping in and out (even venerable Warren Buffet has underperformed the S&P 500 recently). Unless your are a professional money manager, or have hours every day to monitor your portfolio, conducting an active management strategy is not in your best interest long term. It’s much more efficient to spend time doing the things you are good at to maximize wealth and happiness.

The solution to crossing #2 off the list is to simply hire someone to monitor and rebalance your portfolios for you. No matter how much experience I have in finance, I’d much rather be writing, traveling, and spending time with my family than checking my portfolio every day for risk exposure. In fact, if I had let Personal Capital manage my IRA, I would likely be ahead year-to-date instead of down 15% thanks to a collapse in high-flyers such as LinkedIn, Netflix, and Sina. There’s more research that shows how equal-weighted indexes perform better than market cap-weighted indexes if you’re interested.


For the average person, it’s just not worth trying to spend time making money with money for short-term gains. It’s an empty feeling that gets exacerbated when you start losing money because you’re reminded of your stupidity as well as your lighter retirement account.

If you’re looking for a new way to invest and have a tendency to think you’re smarter than you really are, Smart Indexing looks like a solid investment alternative. Not only will your Personal Capital advisor come up with the best financial strategy to suit your needs, they will also help you diversify across multi-asset classes, dynamically rebalance your portfolios, and tax optimize when appropriate. Click here to sign up for Personal Capital’s free financial dashboard and request to speak to an advisor today.

What are your thoughts about continuously investing in equal weightings across sectors vs. a market-cap weighted approach? Is it fair to say that the Smart Indexing approach is more appropriate for conservative investors even though the performance in this post shows that performance is greater?

Join Personal Capital to learn more about Smart Indexing

Disclosure: The Tactical Weighting Strategy shows hypothetical index results, and does not reflect an actual account or trading. Nor does it reflect the impact of fees and expenses that would be incurred by a managed account or fund attempting to follow an indicated index strategy. It is not possible to invest directly in an index or strategy without fees and expenses. Based on available data, the hypothetical results are time linked equal returns of size, style and sector indexes. From 1991 to 1995, it is an average of equal weighted S&P sectors and an equal weight of the S&P 500 and Russell 2000. From 1996 to 2011, it is an average of equal weighted S&P sectors and the nine Russell Style box indexes. Standard deviation is only inclusive of full year return figures. Results assume the reinvestment of dividends. Past performance is no guarantee of future results. Transaction costs, management fees, taxes and other factors, all of which would impact returns, are not considered in the analysis. It is not possible to invest directly in an index or strategy without incurring fees and expenses. All investments involve risk of loss. There can be no assurance that any strategy will be profitable, or that the portfolios described above will perform better than the S&P 500 or other market-weighted index.Actual Performance: Actual Result is performance for our Tactical America strategy, a US equity only strategy. For the calculation, 2012 results were calculated as an average of actual client portfolio returns within the strategy. Only accounts trading for the full calendar year with no material additions or withdrawals were included. For the composite, returns are derived by linking respective quarterly returns. Past performance is not a guarantee of future return, nor is it necessarily indicative of future performance. Performance is shown net of fees and reflects the reinvestment of interest and dividends. Accounts in the composite are billed on a tiered fee schedule and larger
accounts generally pay a lower overall fee rate than other accounts. Accounts with greater than ten percent individual custom restrictions resulting in greater than two percent difference in performance results were not included. Individual account performance will vary depending upon the amount of assets under management and the timing of any additions and withdrawals and may be higher or lower than the performance depicted. [Advisory fees for the accounts included in the performance data ranged from annual rates of 0.75% to 0.95%, depending on the size of the account. Performance for employee and other affiliated accounts has been
recalculated to reflect the standard fee schedule rather than the discounted fees
paid by some of those accounts.

The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.

Any reference to the advisory services refers to Personal Capital Advisors Corporation, a subsidiary of Personal Capital. Personal Capital Advisors Corporation is an investment adviser registered with the Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training nor does it imply endorsement by the SEC.

Sam Dogen is the author of the new personal finance book "Buy This, Not That: How To Spend Your Way To Wealth And Freedom." Sam has been using Personal Capital to keep track of his finances for 10 years. He is the founder of Financial Samurai, one of the largest independently-owned personal finance sites with over one million visitors a month.
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