Quick, what’s the difference between a market-cap-, equal- and price-weighted stock market index? Fortunately, if you’re not sure, our friends at Dimensional Fund Advisors just published an excellent piece on this very subject. We invite you to read it here, but here’s our overview.

If you think of a market as a big box, there are several ways each stock that belongs in that box might “weigh in” to help fill it:

Market-Cap Weighted – If we fill a market box according to each stock’s market capitalization (share price multiplied by shares outstanding), the stocks with the biggest market caps (e.g., Apple stock –  AAPL) weigh the heaviest, or occupy the most space, as Dimensional depicted here:

Equal Weighted – If, each security is instead given equal space in the box regardless of its market-cap, an equal-weighted market will look more like this:

Price Weighted – As described in this recent New York Times piece (which may require a subscription to access), the Dow Jones Industrial Average is the only popular index that uses price weighting, where the highest-priced stocks take up the most space. (Almost everyone agrees, price-weighting is pretty arbitrary, especially since the Dow tracks only 30 U.S. stocks to begin with. But as the world’s first and oldest index, the venerable Dow essentially gets to do as it pleases.)

So what does all this mean to you as an investor? As Dimensional’s illustrations depict:

• If you were to invest all of your money in a single market-cap-weighted index fund, you’d end up holding a much heavier allocation to large-cap stocks, be they value or growth.
• If you were to invest everything in an equal-weighted index fund, you’d end up holding more small-cap stocks than would otherwise be warranted by their cap-weighted presence in the total market.

Now, here’s where things get a little complicated, so bear with me. At first glance, you might conclude you’d be best off investing in an equal-weighted index fund, to capture more of the higher expected small-cap value premium. After all, that’s where the biggest small-cap value “blob” appears, right?

Not so fast. First, we’ve got to remember that an index is just a theoretical collection of stocks. When an investor or fund manager seeks to replicate an index by placing actual trades on those stocks, they run into real-life trading constraints. This is especially so when tracking an equal-weighted index, where far more frequent trading is likely to be the norm.

Put plainly, keeping up with the evolving components in an equal-weighted index can get very expensive, very fast.

Dimensional explains:

“[U]sing a systematic and purposeful approach that takes into consideration real-world constraints is more likely to increase your chances for investment success. Considerations for such an approach include things like: understanding the drivers of returns and how to best design a portfolio to capture them, what a sufficient level of diversification is, how to appropriately rebalance, and last but not least, how to manage the costs associated with pursuing such a strategy.”

Which brings us back to evidence-based investing as we know it. Want to know more? Here’s a past post on index- vs. evidence-based investing. Or just give me a call to continue the conversation.

End notes:
Exhibit 1: For illustrative purposes only. Illustration includes constituents of the Russell 3000 Index as of December 31, 2016, on a market-cap weighted basis segmented into Large Value, Large Growth, Small Value, and Small Growth. Source: Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. See Appendix (on page 3) for additional information.

Exhibit 2: For illustrative purposes only. Illustration includes the constituents of the Russell 3000 Index as of December 31, 2016 on an equal-weighted basis segmented into Large Value, Large Growth, Small Value, and Small Growth. Source: Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. See Appendix (on page 3) for additional information.

No doubt about it. All of us here at Hill Investment Group are one team, regardless of whether we work out of St. Louis, Houston or wherever our clients want us to be. That said, we’re not without our civic pride. Let’s just say some of us more loudly cheer on the Astros, while others of us favor the Cardinals.

What else makes our home bases special in their own rights? We thought it would be fun to launch a series to share some of our cities’ favorite features and interesting oddities. We’ll start with a few points of historical pride.

History

• St. Louis – Founded in 1764 by Pierre Laclède and Auguste Chouteau, named after the 13^th Century French King Louis IX. Our famed Arch commemorates our reputation as the “Gateway to the West,” from where Lewis & Clark launched their 1804 expedition.
• Houston – Found in 1836 by brothers John and Augustus Allen, named after former General Sam Houston, a commander in the Texas Revolution for independence from Mexico. We’re probably best known for our oil and aerospace industries.

Famous Folk

• Houston – Jeff Bezos, Beyoncé, George H.W. and George W. Bush, A.J. Foyt, Howard Hughes, Dan Rather, Renée Zellweger.
• St. Louis – Maya Angelou, Yogi Berra, George Foreman, Redd Foxx, Ulysses S. Grant, Kevin Kline, Charles Lindbergh.

 Musical Heritage

• St. Louis – An early mecca for St. Louis blues, jazz, R&B and ragtime – Chuck Berry, Sheryl Crow, Miles Davis, Scott Joplin, and Ike & Tina Turner have called St. Louis home.
• Houston – Houston also hosts musicians across every genre – and who often cross multiple styles. Notables include Yolanda Adams, Clint Black, Lyle Lovett, Kenny Rogers and ZZ Top.

On Location (movies filmed or set in our home towns)

• Houston – “Apollo 13,” “Boyhood,” “Independence Day,” “Rushmore,” “Selena,” “Urban Cowboy.”
• St. Louis – “Escape from New York,” “Larger Than Life,” “Meet Me in St. Louis,” “National Lampoon’s Summer Vacation,” “White Palace.”

Want to know more? In a future installment, we’ll share some of our favorite things to see, do, eat and drink in our respective home towns! And, by the way, if you’re ever visiting us in either locale, please let us know. We’d love to give you a grand tour of our favorite hot spots.

Have you ever wondered what Batman & Robin would be like if Batman were the understudy to a more famously popular Robin? It would probably be a lot like the real-life dynamic duo of Warren Buffett and Charlie Munger.

As Chairman of Berkshire Hathaway, Buffett is the more familiar figure. He’s been featured in his own HBO special. He’s got his own “Oracle of Omaha” nickname. He’s chairman of Berkshire Hathaway. Munger is vice-chair of the same, and often described as Buffett’s sidekick, even though he’s the elder of the two, is also an astute Omaha native, and was running his own successful holding company while Buffett was still learning the ropes. As Buffett himself describes of Munger:

“[W]e’ve never had an argument. When we differ, Charlie usually ends the conversation by saying: ‘Warren, think it over and you’ll agree with me because you’re smart and I’m right.’”

So who’s the real “Batman”? Let’s turn the spotlight on Munger for a change, showcasing some of his “elementary worldly wisdom” – a phrase Munger uses to describe how he builds models for converting isolated insights into applicable common sense.

Translating the complex into useful ideas. This is something we like to do here at Hill Investment Group as well. To get a sense of how a master like Munger does it, here’s a 15-minute YouTube video with excerpts from a talk on human psychology, which Munger delivered at Harvard in 1995.

Munger uses approachable analogies ranging from Pavlov’s dogs and New Coke, to target shooting and gallbladder surgery to entertain and inform us with “how humans trick themselves into making terrible errors of judgment.”

In our best judgment, Munger is well worth watching and reading, with plenty more elementary worldly wisdom to share. If that’s of interest, let us know and we’ll be glad to tell you more.