We shouldn’t call it Buy and Hold

Mebane Faber is absolutely correct.  This article gives wonderful examples of why cap weighting is problematic, and ways to determine when a sector or market is off kilter.  When you buy cap weighted, by definition you are buying too much of that which is overvalued and too little of that which is undervalued.  Which is why Rob Arnott’s monkeys can beat a cap weighted portfolio.

However, I think that a lot of advisors, like us, who call their philosophy “Buy and Hold,” really don’t exactly just buy and hold.  We don’t.  Maybe we should call it “Allocate Thoughtfully and Rebalance Annually.”

In fact, you can use all cap weighted funds or ETFs and still not really end up with that bubble problem, if you are rebalancing at least annually.  Certainly the funds that contain the bubble, you will end up with too much of the bad and not enough good within those funds, but when you rebalance, you will be selling some of that bubble in comparison to the other funds in your portfolio, so depending on how fragmented of a portfolio you are willing to construct, I think you could really eliminate a lot of this cap weighting risk.

Of course, if you really want to eliminate the concentration risk, you can use a fund or ETF that is fundamentally, or equally, or any way other than cap weighted.  Just be sure you understand what you are buying.

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