Question: If everyone believes that small-cap index funds will outperform and have better results, won’t everyone invest in them until they become overvalued and not such an amazing deal anymore?
Answer: There are times when that happens to all asset classes. In the 1995 through 1999 period, the S&P 500 became way over priced. That period was followed by a 10-year period of under performance. This is where rebalancing goes to work.
As the S&P was compounding at 28.5% a year (1995-99), our firm was rebalancing the excess returns to small cap, value, and international asset classes. This is a strategy that guarantees you sell asset classes while they are high (part of them) and buy asset classes that are not as popular. Our clients were frustrated we only had 10% of our equities in the S&P 500 during the 1995-1999 period… but very happy we only had 10% of our portfolio in the same asset class during the 10 years of under performance.
Once an investor gets past trying to guess what is going to be the better performer, and builds their portfolio with asset classes that are likely to be great performers over the long term, managing a portfolio becomes very easy. I suggest that you take a look at my recommended asset allocation and recommended funds, at paulmerriman.com.