If you remember, Kumar, I recommended about three years ago in the forum that you focus your efforts on mid- and large-cap stocks. As I recall, you responded to me (I’m paraphrasing from memory) that academic studies have shown small-cap stocks have a record of performing better than large companies. I subtly implored you to move higher in market capitalization with your P123 work because larger shares have less volatility and are more predictable.
At that time you were a newbie, and I could see that you are making frequent newbie mistakes of grasping for performance without considering how the inherent volatility of small stocks would affect you emotionally. Although I’m sure you didn’t do it because I recommended it, I was pleased to see it when you began posting about the stable, smooth returns of your S&P 500 portfolio.
I have seen hundreds of beginning investors do what you were doing - but stubbornly insist on sticking with what they think will be the highest returning stocks, which are usually small-cap stocks. Invariably, a market downturn occurs, and it punishes small stocks exponentially more severely than larger companies. After a long bullish-period of gains (which causes recency bias), they believe that they have to stick with their positions and not try to time the market (which they have been told is impossible). When the market keeps going down this time, they are shocked! - shocked! to discover they can actually lose a lot of money. Nevertheless, they decide to stay with those losing positions until they get back to even (anchoring) because they don’t to have a record (in their minds only, usually) of being a ‘loser.’ Ultimately, they do capitulate and sell all of their shares so that they can at least get some of their money back. Unfailingly, this “SELL IT ALL!” response occurs just before the market bottoms and begins to climb again.
Those neophyte investors that were small-cap fan-boys often throw up their hands and give up on investing. They usually end up buying an annuity or something equally as inane and are never heard from again. I’m glad to see that you didn’t abandon investing at the first sign of trouble, Kumar, but instead adjusted your selection criteria to focus on larger enterprises that are more reliable and consistent producers of return. Good for you!
Don’t get me wrong, small- and micro-cap stocks are investable, but I believe this group of stocks should only be targeted by investors with many years of experience - after they have witnessed more than one severe sell-off, or even a couple of market crashes (such as 2008-2009). We have not seen a sharp selloff since you began investing (I only know that you started with P123 in 2013).
I’m glad to see that you have embraced large companies – and based on the posts you have made in this forum about your S&P 500 and other portfolios, you are doing quite well. If you asked me to give you advice again today, I would say to continue to avoid investing in small- or micro-cap companies and stick with that with what’s already in your wheelhouse (large-caps). As you have identified in this post and others, small businesses are less than advantageous for a relatively new investor. They are especially at a disadvantage at this point as investors have embraced the (large-cap) ‘generals’ and are disregarding the (small-cap) ‘soldiers’ for the last 4.5 years.
Those who insist on putting new money into small and micro-cap companies at this time, with a market top in sight, could soon violate Buffett’s Rule #1.
Best of luck,
Chris
PS - You might consider developing a small-cap portfolio that you only trade on paper. When the market sell-off/recession occurs next year, treat it just as you would a real-money portfolio (easier said than done) and watch how it is affected compared to your S&P 500 and other portfolios. Notice especially how the price action in those small companies affects your emotions - and learn from it! (Keep in mind that you will never experience the degree of emotions you would if it was your real hard-earned dollars at stake). Better yet, design a mid-cap portfolio (hint: mid-cap ports usually require a bit different rankings and rules than large-caps, but much of your work can cross over).