DON'T BE FOOLED BY FALSE DIVERSIFICATION

[MrGville]

I was reading a document put out by Personal Capital, and there was a section titled ' Don't Be Fooled By False Diversification.'  This section included the following text:

Don’t rely solely on index funds or mutual funds for portfolio diversification. Broad
market indices are typically weighted by individual companies’ market capitalizations and
therefore provide a false sense of diversification. Most people don’t realize that by being
top-heavy in the biggest holdings, these ETFs are susceptible to downswings based on the
outcome of a few large stocks. Imagine what will happen to your portfolio if one of these
stocks turns out to be the next Enron or Lehman Brothers.[/i

What do MMM'ers think about this?  It makes some sense, but I understand that a lot of people on this blog and many personal finance bloggers have the majority (or all) of their money in a total stock market index fund.  Let me know your thoughts!

[FIPurpose]

I listened to sales speal from PC one time. It's not just a free service, they are looking to do some portfolio management for about 1% fee.

They're whole investment idea is to equally weight across sectors rather than market cap. They show that this leads to better returns (about 1% better ironically enough). So this is there little scare statement to get you to buy in.

I don't think their managent would be terrible and I might one day even have them manage a part of my portfolio, but it's all a part of what they're trying to sell.

[frugaliknowit]

I tend to agree.  Look at what happened in Japan.  Home country and Large Cap bias is pervasive.


http://paulmerriman.com/10-reasons-dont-like-vanguards-total-stock-market-index-fund/

https://paulmerriman.com/vanguard/

[Sibley]

Should you understand how the index fund is weighted? Absolutely. Should you solely trust what one company who has a clear bias on the topic says? Absolutely not.

The weighting information should be in the fund prospectus. That should tell you what you need to know.

[Laserjet3051]

Agree that one need be astutely aware of their asset allocation, true diversification, and risk. All the info is there to feast upon. But this firms scare tactic is profit motivated.

With a 60/40 portfolio, where ones only equity investment was total US market, the single biggest investment would be in Apple, where it would comprise a measly 1.65% of total investments. Throw international diversification into that 60/40 portfolio, and the 1.65% drops even further.

[SwordGuy]

Agree that one need be astutely aware of their asset allocation, true diversification, and risk. All the info is there to feast upon. But this firms scare tactic is profit motivated.

With a 60/40 portfolio, where ones only equity investment was total US market, the single biggest investment would be in Apple, where it would comprise a measly 1.65% of total investments. Throw international diversification into that 60/40 portfolio, and the 1.65% drops even further.

And if Apple tanks, one or more of the thousands of companies you probably already own in your index funds will leap into that gap and fill it with their products, making way more profits than before, and restoring the index in (relatively) short order.  :)

[bacchi]

Comparing RSP to SPY looks like a good 'ol ass kicking. The yield on SPY is higher and this chart doesn't take that into consideration.

https://yhoo.it/2HJm2Rv

[boarder42]

the answer to the question they ask at the end is less than 2% drop in your total portfolio assuming they dont own the asset that takes the place of the company that went away - but the index probably holds that. if you're afraid of losing 2% of your portfolio in any given day you probably should re - evaluate your ability to FIRE using equities. 

[Shane]

Listened to PC's spiel on their strategy and told their rep, "no thanks," in 2016. A few months later, a woman called back to check if, maybe, I'd changed my mind. I told her nicely that even if PC's service were free, I wouldn't do it. She laughed and thanked me for being honest. It just makes no sense to me to try to allocate money evenly between made up categories of stocks like: energy, healthcare, financials, etc. Why should I invest equally in each of those categories? I'd rather own stocks according to each company's market capitalization. Apple has a bigger market cap than Starbucks for a reason. I want to own more Apple stock than Starbucks'.