Risk v. Reward in the stock market

[maxtower]

I like index investing, and I am planning to put some significant cash into an index in the near future. Does anyone have any good information on which stock market indicies are the least volatile. The S&P 500 may be too swingy for the return it offers. Would buying the Russel 1000 Value or 2000 Value offer less risk with the same or better rewards? How about the Mergent Dividend Acheivers? It has beaten the S&P since 1983.
It just seems to me that one of these more value oriented stock indicies can beat or match the S&P returns with less risk. I am looking for some historical data to back that up. I did a little research on the internet, but most info only contains data from the last few years. I was hoping for something more long term.

[ahnuld]

just run the yearly returns in excel and get a regression line. Which ever index has lower mean squared error is probably better for you.

[maxtower]

......MA50 DJDS Rus1000v Rus2000v S&P
1997 28.70% 37.83% 35.18% 31.78% 33.40%
1998 10.53% 4.33% 15.63% -6.45% 28.60%
1999 -4.20% -4.08% 7.35% -1.49% 21.00%
2000 42.34% 24.86% 7.01% 22.83% -9.10%
2001 22.42% 13.09% -5.59% 14.02% -11.90%
2002 0.03% -3.94% -15.52% -11.43% -22.10%
2003 25.13% 30.16% 30.03% 46.03% 28.70%
2004 16.97% 18.14% 16.49% 22.25% 10.90%
2005 0.73% 3.77% 7.05% 4.71% 4.90%
2006 13.09% 19.56% 22.25% 23.48% 15.80%

cumul. 396.05% 356.93% 283.89% 347.71% 224.52%


Ok, I looked up the data for the last 10 years, and it appears that the S&P 500 was pretty much the worst thing you could have been invested in. I wish I could have gotten data for 20 years, but these are newer indexes. I imagine that over 20-30 years the returns will converge to be fairly similar, with the value funds have a slight edge over the S&P 500.

From left to right my comparison includes, the Mergent Dividend acheivers 50, Dow Jones Div. Select, Russell 1k value, and 2k value, and finally the s&P 500.

What is of most interest to me is that from this chart it appears the dividend indices have lower variance compared to the other indices. There are fewer and smaller negative years. I think there is certainly a reason for this. Dividends can not be fudged, overstated or understated. They are real returns. Given that, it is very difficult for a stock with a healthy dividend to really get punished in the market because there will be a floor at which point a lot of buyers will jump in to take advantage of the outsized dividends. Of course if no one has faith in the future ability to pay, then the price will fall. But compared to a stock which doesn't pay dividends and its clear why there is more variance associated with the non-payers.
The Mergent list only includes companies which increase their dividends every year for at least 10 years. This is also a great benefit because it implies that
1. Earnings are increasing and the business is healthy and stable.
2. When dividends go up, the share price will follow. So you get the return of the actual dividend payment plus the capital gain.

There is a caveat (I think). When you buy dividend heavy stocks in a taxable account, you will have to pay taxes as you go along each year on a lot of your returns, compared to owning a stock which compounds without paying dividends. In the latter case, you'll only pay capital gains taxes once you sell.

[NajdorfDefense]

Virtually any equal-weighted or value-weighted index like those available at WisdomTree or any ETF shop should beat the SPX over time.

[maxtower]

Wow. I just looked at Wisdom Tree's website. I haven't heard of them before. They have been slaughtering the S&P 500. Thanks for the reference. I am going to see about adding them into my mix. The evidence for value/dividend indexing over the standard total market approach is pretty compelling.

[iversonian]

[ QUOTE ]
Virtually any equal-weighted or value-weighted index like those available at WisdomTree or any ETF shop should beat the SPX over time.

[/ QUOTE ]

The way these non-cap weighted index funds differ from the cap weighted ones is that they are overweight on the smaller cap issues and, during each rebalancing period, they sell the winners and buy the losers in some proportion. To say what you're saying is equivalent to saying that A. small caps will outperform large caps and/or B. reversion trends are stronger than momentum trends on a quarterly time scale (which is usually how often these funds rebalance). B used to be true until fairly recently, but hardly so anymore. There is a lot of support for A, but is that the basis of your claims and would you go so far as to call it a certainty in the long term?