SteadyOptions is an options trading forum where you can find solutions from top options traders. Join Us!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

The Best Chart I’ve Seen in 2020


The best visual aids for learning are often very simple. The chart in this article was created by Paul Merriman, using data from Dimensional Fund Advisors. I primarily use Dimensional Funds in building portfolios for my clients. There are many takeaways from this chart, and I’d like to share a few thoughts that stick out most to me.

But first, a few definitions:

  • “SCB”: Small Cap Blend. This represents an index of US small cap stocks
  • “SCV”: Small Cap Value. This represents an index of US small cap value stocks
  • “LCV”: Large Cap Value. This represents an index of US large cap value stocks
  • “4-Fund Combo”: Equal weight S&P 500, LCV, SCB, and SCV

image.png

 

Academic theory suggests that markets are highly efficient at pricing asset classes so that risk and reward are related. When an asset class has more risk, it should also have a higher expected return. Otherwise why take the risk? Specifically, from lowest risk/reward to highest:

  • 1-month T-bills (cash)…lowest risk, lowest expected return
  • Long term government bonds
  • Large cap stocks (S&P 500)
  • Large cap value stocks
  • Small cap stocks
  • Small cap value stocks…highest risk, highest expected return

We see that the historical data matches the theory over the entire period. But certainly not over every 15-year period, which should be expected…otherwise there wouldn’t be risk if we knew with certainty that holding for 15 years would automatically produce a relative outcome of one asset classes versus another. Therefore, there is no period long enough where we can be certain of any outcome in markets. And for this reason, every investor must consider their own personal ability, willingness, and need to take risk. This is true not only for how much a portfolio should be in stocks vs. bonds, but also how much of that equity allocation should consist of small cap and value stocks. The right portfolio is the one that has the highest probability of meeting your long-term return objectives(one that is well diversified) and is also one that you can stick with.

 

The diversification of the 4-fund combo never gives you the best outcome, which is a price to pay for also avoiding the worst outcome that you’re more likely concerned about. The period of 1960-1974 stands out, a period of 15 years when the popular S&P 500 index underperformed totally riskless 1-month T-bills (along with SCB & LT Gov Bonds). The 4-fund combo, due to the performance of value stocks, still produced a risk premium over T-bills.

Over the long-term, which is the only period an equity investor should care about, diversification can reduce worst case scenarios. Yet it’s interesting that when I review the portfolios of new clients and prospects, it’s extremely rare to find any allocation at all to small cap value stocks. Whether that portfolio was built with the help of an advisor or not hasn’t seemed to matter, indicating that lack of awareness of the historical data is the likely explanation. I’ve written extensively in
other articles about the higher expected returns of small and value stocks, as this has been known for at least 30 years.

 

The last point I’ll make is that the same chart created with shorter periods, such as 1/5/10 year periods, has much more random outcomes. Again, this would be expected, and it’s why increasing your awareness of the range of potential outcomes over various time periods is one of the best things you can do to have proper expectations. My recent articles on market volatility digs deeper into this topic.

 

Conclusion

 

We should all attempt to judge the quality of every decision we make in our lives not solely based upon the after the fact outcome but based on the information we had available at the time of making the decision.  With investments, this is especially true as we can only have historical data and academic theory to guide us. The science of investing is not like other forms of science where laws exist creating certainty of cause and effect outcomes. This means we should focus our attention on the things we can control such as diversification, asset allocation, and rebalancing. Once we’ve built our portfolios according to these principles, we can relax knowing that we’ve maximized our probability of having a successful investment experience.

 

Jesse Blom is a licensed investment advisor and Vice President of Lorintine Capital, LP. He provides investment advice to clients all over the United States and around the world. Jesse has been in financial services since 2008 and is a CERTIFIED FINANCIAL PLANNER™ professional. Working with a CFP® professional represents the highest standard of financial planning advice. Jesse has a Bachelor of Science in Finance from Oral Roberts University. Jesse manages the Steady Momentum service.

 

Related articles

 

What Is SteadyOptions?

12 Years CAGR of 123.5%

Full Trading Plan

Complete Portfolio Approach

Real-time trade sharing: entry, exit, and adjustments

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Subscribe to SteadyOptions now and experience the full power of options trading!
Subscribe

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles

Articles

  • 7 Helpful Tips To Invest Your Money And Time In 2025

    While many of us would like to not think too much about how much money controls the world, it certainly is a primary motivator for most people in life. Whether you earn to pay the bills or work to succeed in a career you’re passionate about, money is something that can help greatly in making your life more comfortable and enjoyable.

    By Kim,

    • 0 comments
    • 4,193 views
  • Diversification Dos And Don'ts

    It’s one of the golden rules of stock trading: ‘don’t put all your eggs in one basket’. More formally known as ‘diversification’. By spreading your funds among several stocks, you help spread the risk. But is stock market success really as simple as that? As with many things in life, the devil is in the details.

    By Kim,

    • 0 comments
    • 11,560 views
  • Predicting Probabilities in Options Trading: A Deep Dive into Advanced Methods

    In options trading, the focus should not be on predicting the exact closing price of a ticker on a given date - a near-impossible task given the pseudo-random nature of markets. Instead, we aim to estimate probabilities: the likelihood of a ticker being above a specific value at a certain point in time. This perspective turns trading into a probabilistic exercise, leveraging historical data to make informed decisions.

    By Romuald,

    • 1 comment
    • 8,107 views
  • SteadyOptions 2024 - Year in Review

    2024 marks our 13th year as a public trading service. We closed 136 winners out of 187 trades (72.7% winning ratio). Our model portfolio produced 116.7% compounded gain on the whole account based on 10% allocation per trade. We had only one losing month (of 0.6% loss) in 2024. 

    By Kim,

    • 0 comments
    • 1,495 views
  • The 7 Most Popular Cryptocurrencies Right Now

    There are thought to be 20,000 cryptocurrencies currently in existence. While a lot of these are inactive or discontinued, a lot of them are still being traded on a daily basis. But just which cryptocurrencies are most popular? This post takes a look at the top 7 most traded cryptocurrencies.

    By Kim,

    • 0 comments
    • 8,148 views
  • Harnessing Monte Carlo Simulations for Options Trading: A Strategic Approach

    In the world of options trading, one of the greatest challenges is determining future price ranges with enough accuracy to structure profitable trades. One method traders can leverage to enhance these predictions is Monte Carlo simulations, a powerful statistical tool that allows for the projection of a stock or ETF's future price distribution based on historical data.

    By Romuald,

    • 10 comments
    • 12,290 views
  • Is There Such A Thing As Risk-Management Within Crypto Trading?

    Any trader looking to build reliable long-term wealth is best off avoiding cryptocurrency. At least, this is a message that the experts have been touting since crypto entered the trading sphere and, in many ways, they aren’t wrong. The volatile nature of cryptocurrencies alone places them very much in the red danger zone of high-risk investments.

    By Kim,

    • 0 comments
    • 5,846 views
  • Is There A ‘Free Lunch’ In Options?

     

    In olden times, alchemists would search for the philosopher’s stone, the material that would turn other materials into gold. Option traders likewise sometimes overtly, sometimes secretly hope to find something which is even sweeter than being able to play video games for money with Moincoins, that most elusive of all option positions: the risk free trade with guaranteed positive outcome.

    By TrustyJules,

    • 1 comment
    • 18,778 views
  • What Are Covered Calls And How Do They Work?

    A covered call is an options trading strategy where an investor holds a long position in an asset (most usually an equity) and sells call options on that same asset. This strategy can generate additional income from the premium received for selling the call options.

    By Kim,

    • 0 comments
    • 3,885 views
  • SPX Options vs. SPY Options: Which Should I Trade?

    Trading options on the S&P 500 is a popular way to make money on the index. There are several ways traders use this index, but two of the most popular are to trade options on SPX or SPY. One key difference between the two is that SPX options are based on the index, while SPY options are based on an exchange-traded fund (ETF) that tracks the index.

    By Mark Wolfinger,

    • 0 comments
    • 10,658 views

  Report Article

We want to hear from you!


There are no comments to display.



Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account. It's easy and free!


Register a new account

Sign in

Already have an account? Sign in here.


Sign In Now

Options Trading Blogs