Author Topic: Diversification, huh, What is it Good For? Absolutely Nothin'  (Read 9423 times)

ThatGuy

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OK, that might be a bit of an overstatement but let me explain what I'm thinking.  My retirement account choices are all index funds so each asset class is diversified.  For example the stock fund mirrors the S&P 500 and the small cap fund follows the Russell 2000 etc.  But looking over each fund none of them really seem to do all that well except the S&P.  I understand the need for diversification, it's obviously too risky to have all your money in one stock but is it really necessary to have your money in multiple asset classes during your accumulation years?  It seems to me that multiple asset classes are really only beneficial when you are retired and withdrawing money and you want/need the ability to withdraw from investments that are doing well and leave alone the ones that are in a down cycle.  If you invest in funds that are always mediocre you're just watering down the overall return you earn.  Am I missing something here?

MDM

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retireatbirth

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Re: Diversification, huh, What is it Good For? Absolutely Nothin'
« Reply #2 on: May 11, 2015, 09:08:38 PM »
Because the US equities bull run might end. Just look at Australia and Japan markets. Those countries are no slouches and look what happened. I doubt it'll happen to US equities cause of so many multinationals and being such a global player, but you never know.

Indexer

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Re: Diversification, huh, What is it Good For? Absolutely Nothin'
« Reply #3 on: May 11, 2015, 09:11:52 PM »
Domestic stocks have outperformed international stocks the past few years. 

There have been periods where international outperformed domestic.

Small caps can also outperform large cap and vice versa.

So you should be in at least small stocks, large stocks, and international stocks.

Bonds likely aren't going to perform as well as stocks over the long term.  Bonds are there as a hedge against stock market volatility.  100% stock portfolio historically has averaged 10% returns but can see 40-50% drops.  A 60% stock, 40% bond portfolio has averaged around 8.5% and can see 26% drops.  Slightly less returns, drastically less risk.  Now if you are comfortable with 100% stocks have at it, but this is why people have bonds in their portfolio.

Mighty-Dollar

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Re: Diversification, huh, What is it Good For? Absolutely Nothin'
« Reply #4 on: May 11, 2015, 10:14:22 PM »
Quote
If you invest in funds that are always mediocre you're just watering down the overall return you earn.  Am I missing something here?
"In study after study, year after year, it has been shown that the vast majority of actively managed mutual funds underperformed their benchmarks" -- Jim Cramer
In other words mediocre (index funds) is the superior choice.

Dodge

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Re: Diversification, huh, What is it Good For? Absolutely Nothin'
« Reply #5 on: May 11, 2015, 10:26:39 PM »
OK, that might be a bit of an overstatement but let me explain what I'm thinking.  My retirement account choices are all index funds so each asset class is diversified.  For example the stock fund mirrors the S&P 500 and the small cap fund follows the Russell 2000 etc.  But looking over each fund none of them really seem to do all that well except the S&P.  I understand the need for diversification, it's obviously too risky to have all your money in one stock but is it really necessary to have your money in multiple asset classes during your accumulation years?  It seems to me that multiple asset classes are really only beneficial when you are retired and withdrawing money and you want/need the ability to withdraw from investments that are doing well and leave alone the ones that are in a down cycle.  If you invest in funds that are always mediocre you're just watering down the overall return you earn.  Am I missing something here?

In the 5 years prior to the 2007 market top, US stocks had incredible gains, and doubled during this time.  But you would've missed out if you were 100% US, as International stocks tripled:



If you can predict which asset classes will outperform in the future, then sure, put everything there.  Unfortunately, you don't have a crystal ball.  No one does.  What you're doing in lieu of a crystal ball, is using past returns to predict future results, which is a verified losing strategy.  I recommend watching the short Bogleheads video series on this:

http://www.bogleheads.org/wiki/Video:Bogleheads®_investment_philosophy

Particularly videos #4 and #6.
« Last Edit: May 12, 2015, 12:14:34 AM by Dodge »

mrpercentage

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Re: Diversification, huh, What is it Good For? Absolutely Nothin'
« Reply #6 on: May 11, 2015, 11:33:17 PM »
The more mediocre you make your returns.. the safer.

I think diversification is overdone. You can't reduce risk in one area without exposing yourself to more risk in another. Otherwise stated, if you buy everywhere you are guaranteed to lose somewhere.

By choosing everything you pull down the valuable traits of the strong and are guaranteed mediocracy. Crap Im talking Neitzche again.

CorpRaider

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Re: Diversification, huh, What is it Good For? Absolutely Nothin'
« Reply #7 on: May 12, 2015, 06:06:25 AM »
Both Buffett and Bogle have been quoted saying one can use the S&P for most if not all of their equity allocation.

NoraLenderbee

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Re: Diversification, huh, What is it Good For? Absolutely Nothin'
« Reply #8 on: May 12, 2015, 10:42:36 AM »
Wait until we experience a long bear market. Then you'll understand.

rmendpara

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Re: Diversification, huh, What is it Good For? Absolutely Nothin'
« Reply #9 on: May 12, 2015, 10:51:33 AM »
OK, that might be a bit of an overstatement but let me explain what I'm thinking.  My retirement account choices are all index funds so each asset class is diversified.  For example the stock fund mirrors the S&P 500 and the small cap fund follows the Russell 2000 etc.  But looking over each fund none of them really seem to do all that well except the S&P.  I understand the need for diversification, it's obviously too risky to have all your money in one stock but is it really necessary to have your money in multiple asset classes during your accumulation years?  It seems to me that multiple asset classes are really only beneficial when you are retired and withdrawing money and you want/need the ability to withdraw from investments that are doing well and leave alone the ones that are in a down cycle.  If you invest in funds that are always mediocre you're just watering down the overall return you earn.  Am I missing something here?

You say "watering down", others would call that "managing risk".

You are somewhat correct. Depending on your time horizon, and how early you are in the accumulation phase, it's not unheard of to be overweight equities and underweight fixed income. If you want to try this, my own personal (and un-scientific) recommendation would be to plan on investing through at least 2 economic cycles while being overweight equities... or anywhere from 7-15 years... maybe shorter or longer. At some point later, you can either rebalance, or just start adding new capital into fixed income. Or, if you're rich enough and could easily live off the yield alone, then stay all equity focused, and start branching out into more sophisticated classes with longer time horizons and higher returns... like private equity.

Totally up to you on how to proceed, but history suggests staying invested and maintaining a reasonable allocation is more likely to help you succeed than trying to predict the future. There are many people far smarter than you trying to do this, and in recent years, perhaps 100 or fewer hedge/private equity fund managers have been able to do this consistently.

Good luck to you, sir (or madam).

Eric

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Re: Diversification, huh, What is it Good For? Absolutely Nothin'
« Reply #10 on: May 12, 2015, 10:58:37 AM »
OK, that might be a bit of an overstatement but let me explain what I'm thinking.  My retirement account choices are all index funds so each asset class is diversified.  For example the stock fund mirrors the S&P 500 and the small cap fund follows the Russell 2000 etc.  But looking over each fund none of them really seem to do all that well except the S&P.  I understand the need for diversification, it's obviously too risky to have all your money in one stock but is it really necessary to have your money in multiple asset classes during your accumulation years?  It seems to me that multiple asset classes are really only beneficial when you are retired and withdrawing money and you want/need the ability to withdraw from investments that are doing well and leave alone the ones that are in a down cycle.  If you invest in funds that are always mediocre you're just watering down the overall return you earn.  Am I missing something here?

I think what you're missing is that there is no such thing as an "always mediocre" fund.  Sometimes international wins, sometimes large cap, sometimes small cap, etc.  It's impossible to know this ahead of time.  Check out this chart and let me know which asset class you think is going to "win" for the next 5, 10 or 20 years.  If you can find a pattern in this, then you may be able to give Rainman a run for his money.





Wolf359

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Re: Diversification, huh, What is it Good For? Absolutely Nothin'
« Reply #11 on: May 12, 2015, 11:47:48 AM »
The OP has a point.  Early in the accumulation phase, a very high savings rate trumps the return caused by compounding over time.  This is especially true for someone of the Mustaschian bent, who is rapidly saving a stache in a relatively short timeframe.

However, over the long term, diversification comes to the forefront.  Sometimes an asset class has a good run of years, or even a decade.  And sometimes it suddenly tanks.  As stated by others, if you're in the market for the long term, diversification matters, because no one can predict the market.  It's easy to tell who the winner was in hindsight, but not who it will be in the future.

forummm

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Re: Diversification, huh, What is it Good For? Absolutely Nothin'
« Reply #12 on: May 12, 2015, 12:10:10 PM »
Wow, I never thought I'd see someone argue against diversification here.

Some people do bring up the argument of not wanting to own international stocks from time to time for currency risk reasons. But I disagree with that. If you're investing for the long run, international diversification has historically reduced volatility and not decreased total returns.

Franklin

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Re: Diversification, huh, What is it Good For? Absolutely Nothin'
« Reply #13 on: May 12, 2015, 12:23:04 PM »
Wow, I never thought I'd see someone argue against diversification here.

Some people do bring up the argument of not wanting to own international stocks from time to time for currency risk reasons. But I disagree with that. If you're investing for the long run, international diversification has historically reduced volatility and not decreased total returns.

+1.  Seriously, has there ever been a better time to buy International then the past 5 years?

Kaspian

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Re: Diversification, huh, What is it Good For? Absolutely Nothin'
« Reply #14 on: May 12, 2015, 02:31:14 PM »
Your biggest foe in investing is not "mediocre" returns, it's that guy you see in the mirror.  It's easy to say you're not scared of sharks while you're sitting in the boat.

mrpercentage

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Re: Diversification, huh, What is it Good For? Absolutely Nothin'
« Reply #15 on: May 12, 2015, 03:35:06 PM »
Your biggest foe in investing is not "mediocre" returns, it's that guy you see in the mirror.  It's easy to say you're not scared of sharks while you're sitting in the boat.

+1   I like it.

ThatGuy

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Re: Diversification, huh, What is it Good For? Absolutely Nothin'
« Reply #16 on: May 12, 2015, 04:16:12 PM »
Currently my retirement investments break down is:  35% S&P 500, 40% small cap, 15% international, 10% corporate bond.  As far as I can tell the market has recovered from every downturn that has occurred since the market began.  Market movements don't really seem to bother me, in '08 and '09 I saw that as a chance to buy more of what I was going to be buying anyway. Other than the tech bubble of 2000, which the NASDAQ was so skewed towards over the top unproven businesses it was destined to crash, as long as you are a long term investor it just seems to be a waste of time to invest in multiple asset classes.  I guess I need to look at more historical data, my employer has only had the small cap and international funds for about 15 years.  The other two have been around for almost 30.  Thanks for all the opinions and information, even when someone completely disagrees with me their opinion is helpful.

Interest Compound

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Re: Diversification, huh, What is it Good For? Absolutely Nothin'
« Reply #17 on: May 12, 2015, 04:56:15 PM »
Other than the tech bubble of 2000, which the NASDAQ was so skewed towards over the top unproven businesses it was destined to crash, as long as you are a long term investor it just seems to be a waste of time to invest in multiple asset classes.

In this very statement, you provided one of the best reasons to diversify.  Diversification is literally the only free lunch.  By purposely avoiding it, you are almost guaranteeing that you will underperform (end up with less money) and with a higher amount of risk.  This is not opinion, it is an observable fact.

Kaspian

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Re: Diversification, huh, What is it Good For? Absolutely Nothin'
« Reply #18 on: May 13, 2015, 10:08:35 AM »
Other than the tech bubble of 2000, which the NASDAQ was so skewed towards over the top unproven businesses it was destined to crash, as long as you are a long term investor it just seems to be a waste of time to invest in multiple asset classes.

In this very statement, you provided one of the best reasons to diversify.  Diversification is literally the only free lunch.  By purposely avoiding it, you are almost guaranteeing that you will underperform (end up with less money) and with a higher amount of risk.  This is not opinion, it is an observable fact.

Exactly!

"the NASDAQ was so skewed towards over the top unproven businesses it was destined to crash" <--  I'm glad you knew that while most advanced investors didn't.  You must've made a fortune!!! 

beltim

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Re: Diversification, huh, What is it Good For? Absolutely Nothin'
« Reply #19 on: May 13, 2015, 10:35:49 AM »
Other than the tech bubble of 2000, which the NASDAQ was so skewed towards over the top unproven businesses it was destined to crash, as long as you are a long term investor it just seems to be a waste of time to invest in multiple asset classes.

In this very statement, you provided one of the best reasons to diversify.  Diversification is literally the only free lunch.  By purposely avoiding it, you are almost guaranteeing that you will underperform (end up with less money) and with a higher amount of risk.  This is not opinion, it is an observable fact.

This is rarely, if ever, true.  The whole point of the Nobel Prize that Markowitz and Sharpe got was that diversification reduced risk, NOT that it increased returns.*
http://www.moneychimp.com/articles/risk/efficient_frontier.htm

* By that, I mean your return won't be better than the return of the best asset class.
« Last Edit: May 13, 2015, 10:46:56 AM by beltim »

Indexer

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Re: Diversification, huh, What is it Good For? Absolutely Nothin'
« Reply #20 on: May 13, 2015, 05:16:09 PM »
Diversification prevents 100% losses.  That is the point.  Many here are correct that it doesn't increase expected returns.  It does however dramatically lessen the chances of unrecoverable losses.  A well diversified stock portfolio can see 40-50% drops.  It will not see 100% drops unless the world ends... in which case who cares about their stock portfolio?

An individual security has the same expected returns as its asset class, but it has the potential downside of 100%.

Apple had the expected returns of the SP500.  It did much better.

Enron also had the expected returns of the SP500.  It is gone.

You are taking infinitely more risk(the risk of 100% losses) for the slim chance of higher expected returns.  I don't get it.

To use an analogy.  Its like the air bag & seat belt in your car.  If you get in a wreck you want to have that air bag 99.9999% of the time.  Sure it hurts your face/shoulder to hit it.  You may even go to the hospital for a few days(40-50% temporary losses) but it is better than death(100% losses) or extreme injuries you can't recover from(95% losses).  However there is that very very very slim(0.00000000000001%) chance that after a wreck your windshield pops off and you fly through the opening and over the car in front of you without a scratch and land in the back of this.....


Technically it could happen.  Technically you could have bought Apple in 1985 based on dumb luck, never bought any other company, and be stupid rich today(I actually know the person who did this).  However there is a much greater probability you would end up owning something average(don't get in a wreck) but with much more risk, or that you bought something that crashed(Enron, Lehman Brothers, WorldCom, Wachovia, Bear sterns, etc.).

ThatGuy

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Re: Diversification, huh, What is it Good For? Absolutely Nothin'
« Reply #21 on: May 13, 2015, 06:26:02 PM »
Diversification prevents 100% losses.  That is the point.  Many here are correct that it doesn't increase expected returns.  It does however dramatically lessen the chances of unrecoverable losses.  A well diversified stock portfolio can see 40-50% drops.  It will not see 100% drops unless the world ends... in which case who cares about their stock portfolio?

An individual security has the same expected returns as its asset class, but it has the potential downside of 100%.

Apple had the expected returns of the SP500.  It did much better.

Enron also had the expected returns of the SP500.  It is gone.

You are taking infinitely more risk(the risk of 100% losses) for the slim chance of higher expected returns.  I don't get it.

To use an analogy.  Its like the air bag & seat belt in your car.  If you get in a wreck you want to have that air bag 99.9999% of the time.  Sure it hurts your face/shoulder to hit it.  You may even go to the hospital for a few days(40-50% temporary losses) but it is better than death(100% losses) or extreme injuries you can't recover from(95% losses).  However there is that very very very slim(0.00000000000001%) chance that after a wreck your windshield pops off and you fly through the opening and over the car in front of you without a scratch and land in the back of this.....


Technically it could happen.  Technically you could have bought Apple in 1985 based on dumb luck, never bought any other company, and be stupid rich today(I actually know the person who did this).  However there is a much greater probability you would end up owning something average(don't get in a wreck) but with much more risk, or that you bought something that crashed(Enron, Lehman Brothers, WorldCom, Wachovia, Bear sterns, etc.).

You are comparing the risk and reward of individual stocks, Apple and Enron, to an index, the S&P500.  I'm not talking about putting all my money in one stock, I'm talking about putting all my money in one index fund.  If an index fund that follows the S&P 500 loses 100% I would think you have bigger worries than your investments.  What I am questioning is the wisdom of diversifying into multiple asset classes. 

Interest Compound

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Re: Diversification, huh, What is it Good For? Absolutely Nothin'
« Reply #22 on: May 13, 2015, 06:26:36 PM »
Other than the tech bubble of 2000, which the NASDAQ was so skewed towards over the top unproven businesses it was destined to crash, as long as you are a long term investor it just seems to be a waste of time to invest in multiple asset classes.

In this very statement, you provided one of the best reasons to diversify.  Diversification is literally the only free lunch.  By purposely avoiding it, you are almost guaranteeing that you will underperform (end up with less money) and with a higher amount of risk.  This is not opinion, it is an observable fact.

This is rarely, if ever, true.  The whole point of the Nobel Prize that Markowitz and Sharpe got was that diversification reduced risk, NOT that it increased returns.*
http://www.moneychimp.com/articles/risk/efficient_frontier.htm

* By that, I mean your return won't be better than the return of the best asset class.

Sure, if you can predict which asset class will be the best over your specific investment horizon, putting all your money there will result in the highest return.

ThatGuy

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Re: Diversification, huh, What is it Good For? Absolutely Nothin'
« Reply #23 on: May 13, 2015, 08:18:15 PM »
Another point I would like to make is I think a lot of people are confusing volatility with risk.

Indexer

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Re: Diversification, huh, What is it Good For? Absolutely Nothin'
« Reply #24 on: May 13, 2015, 08:37:34 PM »
Another point I would like to make is I think a lot of people are confusing volatility with risk.

If by people you mean the entire finance industry... then yes.  The way most people use the terms they do actually mean the same thing.  Most people see a 50% drop as risky.  So in that since... to most investors, and most investment professionals who work with individual investors... high volatility is risky.  The risk is that high volatility will take someone out of their comfort zone and they will want to sell to get out.  There is also the risk that if you are spending from a portfolio and there is volatility the sequence of returns can still cause you to run out of money where you might not have in a portfolio with less volatility. 

I assume when you say risk you mean the risk of permament loss, or even the risk of not achieving your goals.  This is different than volatility.  You are correct that an index is unlikely to hit zero so there is little risk of permament loss while it will have lots of volatility if it is a volatile set of securities.


So in this sense the risk is if you are in just 1 asset class that asset class might underperform other asset classes over the long term and you fail to hit your goals.  Sure domestic stocks have killed about every other asset class over the past 5 years.  But what about the next five, and the next five? 
« Last Edit: May 13, 2015, 08:39:56 PM by Indexer »

Kalergie

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Re: Diversification, huh, What is it Good For? Absolutely Nothin'
« Reply #25 on: May 13, 2015, 08:54:38 PM »
I have  been thinking about the exact same topic which actually worries me. We read more and more threads that go like "why invest in something that has not performed as well as XYZ? Why not just invest in XYZ which has outperformed everything recently and let's not bother with the losers anymore. Come on, let's go all in."

The more threads I read about similar topics, the more I believe greed is taking over again.  I think it all comes down to each investor's individual situation and almost cannot be answered with generally applicable results for everyone.

ThatGuy

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Re: Diversification, huh, What is it Good For? Absolutely Nothin'
« Reply #26 on: May 13, 2015, 09:43:36 PM »
Well maybe someone can help me out.  I'm trying to find the ticker symbols for the indexes that my employer use.  One of the funds follows the S&P 500 so that's no problem but the other two I can't find or I don't know what I'm doing.  The small cap fund follows the Dow Jones U.S. Completion TSM Index and the international fund follows the Morgan Stanley Capital International EAFE.  Without these ticker symbols I only have the track records for these funds from 2001 to now. 

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Re: Diversification, huh, What is it Good For? Absolutely Nothin'
« Reply #29 on: May 14, 2015, 01:53:42 PM »
What I am questioning is the wisdom of diversifying into multiple asset classes.

Because, "a one-asset strategy is a good strategy," said no one intelligent ever.