There is no standard definition of a small cap stock. The methodology used deciding what stocks are included in a small cap index can result in significant return differences. As of the middle of 2014, The S&P SmallCap outperformed the Russell 2000 for 12 of the last 19 years. The Russell 2000 has been tracking small caps for 30+ years; the S&P SmallCap 600 has been around for 19+ years.

S&P SmallCap 600 vs. Russell 2000

According to a May 2014 WSJ article, after 30 years, a $200,000 mutual fund investment (8% gross annualized return) grows to $1.4 million after paying the typical mutual fund annual fee of 1.25%. This was the average expense ratio for mutual funds for 2013 (source: Morningstar). The same investment grew to $2.0 million if annualized returns were the same but a 0.04% annual expense ratio (source: ETF.com).

A small number of ETFs offer “fundamental” indexing. Virtually all bond indexes assign weights based upon outstanding debt. With fundamental bond indexing, securities are weighted based on measures of the issuers’ financial strength—not the market value of outstanding bonds. Advocates of fundamental bond indexing point out a traditional index (or ETF) could end up overweighting heavy indebted companies, thereby resulting in higher credit risk to investors.

During the 2008 financial crisis, the average ultra-short bond fund lost 7.9% for the year; the Charles Schwab YieldPlus fund lost 35% (note: a lawsuit forced Schwab to pay a $119 million fine to settle SEC civil charges).

For the first half of 2013, the correlation between the S&P 500 and alternative investments has increased—a trait not desired by most advisors. Correlation does not measure degree of movement. Instead it assigns a number between +1.0 and -1.0 to show whether two investments tend to move up and down together.

Closed-end funds (CEFs) trade on exchanges and almost always trade at a NAV discount or premium. For example, at the end of September 2012, 70% of CEFs traded at premiums; a year later, 89% traded at discounts (67% traded at discounts > 5%). One risk often not considered is the fact may CEFs are leveraged, which can magnify yields, losses, and gains. 

The Barclays U.S. Aggregate Bond Index was launched in 1976. Since its 1976 inception, the index’s worst year has been 1994 (-2.92%). Since 1993, the index has had just two negative years, 1994 and 1999 (a loss of ~ 1%). From the beginning of 2013 to the end of August 2013, the index had a total return of -6.8%.

Despite the beating bond funds suffered in June of 2013, bond investors have still done well over the past 3-10 years, particularly those in the PIMCO Total Return Fund (the company’s flagship mutual fund) and the PIMCO Investment Grade Corporate Bond Fund. In 2010, Bill Gross, PIMCO’s chief money manager, was named best mutual fund manager for the decade by Morningstar.

Annualized Returns Through June 24, 2013

In 1948, the Federal discount rate was 1.3%; by 1981, it was 13.4%. During this extensive period (34 years) of rising interest rates, the annualized returns for bonds was 3.83% (4.5% for 3-month T-bills), 11.00% for the S&P 500. Bond returns are based on total return figures for intermediate-term U.S. government bonds from 1948-1975 and the Barclays Aggregate Bond Index returns from 1976-2011.

At the beginning of May 2013, had a average yield of 5.2%, 4.5 percentage points above U.S. government paper—well above the “crazily tight spread of 2.44 percentage points seen just before the (2008) financial crisis (source: WSJ). Issuance of junk bonds hit records in the U.S. and Europe in 2012.

In 1997, a group of Los Angeles-based traders, led by Michael Milken, helped structure and market the first “junk” bond, a $30 million offering for an oil company, Texas International.