Author Topic: Is diversification just another way of lowering returns?  (Read 4895 times)

Jamese20

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Hi guys

I'm just spending lots of time wondering if my future longtime strategy of ls100 fund is a me spreading my money to far to gain extra 'security' which will hamper my long term results not to mention I keep looking at their expense ratio and keep thinking it's too high when I can half the expense by buying us equity and ftse all share maybe just ftse 250 50% split all stocks

Some Intel would be great guys


SeattleCPA

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Re: Is diversification just another way of lowering returns?
« Reply #1 on: May 27, 2017, 11:04:36 AM »
Two comments to help you develop your thinking on risk...

People think (with good reason) that some diversification removes risk from your portfolio that you aren't paid extra return for bearing. This "removable" risk, called unsystematic risk, doesn't jack your return... only jacks your risk... you don't want to bear that risk because you don't have to...

Risk you can't diversify away, called systemic risk, you do get paid extra return for bearing. But you need to be careful to recognize that while the median outcome is higher with riskier investments like, say, stocks, the variability in your outcomes widens.

You can buy a ten-year bond, say, that pays 2% or 3%... but that amount is guaranteed.

You can buy the stock market and hold it for ten years... you may expect to earn 4% or 5% in real terms... but a reasonable guess as to the range of outcomes may be from 0% to 8%...

Jamese20

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Re: Is diversification just another way of lowering returns?
« Reply #2 on: May 27, 2017, 11:13:47 AM »
I understand the basics I just feel that is it worth the. 10% extra to gain extra diversification which indeed might reduce overall return... Are you just trying to outwhit the US Index or UK.

It has performed well the ls 100 but still over the last 5 years it's 2% behind the 5 year average of the US equity fund.

Of course 5 years is nothing but when you consider if trends are to continue or even fall this seems to me that the diversification is just hampering returns over time?

To achieve 2 % less and extra expenses seems an expensive option in the attempt of trying to achieve diversification?


SeattleCPA

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Re: Is diversification just another way of lowering returns?
« Reply #3 on: May 27, 2017, 11:27:48 AM »
Maybe I don't understand. Sorry.

But to restate what I said earlier but in terms of the costs you reference, some diversification reduces your risks without reducing your before expenses returns... it shouldn't cost very much (or anything?) to get this risk reduction... seems optimal to do this...

Some diversification reduces your expected return but also dampens down the variability in your before expenses returns... this also shouldn't cost very much... but this trade-off is really about how you or I feel the risk reward trade-off.

I don't think your costs for this should be very high. In the beginning when your balances are modest, the expense ratios sort of look high. But turn the amounts into dollars and it isn't that bad. A ways down the road, when those same bloated expense ratios look ugly in dollars, you should be able move money to lower cost vehicles in some cases.

Jamese20

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Re: Is diversification just another way of lowering returns?
« Reply #4 on: May 27, 2017, 12:38:10 PM »
Hi seattle

Basically my 2 other fund options I have in mind have an expense ratio of 0.09% and 0.10% whilst the ls100 is 0.22%

So it costs more to diversify and to also hamper the returns at this moment . 2% is a big drop of return especially if your stash is getting to a rather large amount.

So my question is why diversify when the long term goal is to maximise returns over time, especially in the building stage?


Jamese20

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Re: Is diversification just another way of lowering returns?
« Reply #5 on: May 28, 2017, 12:54:58 AM »
Hi Steve

Yes basically,  I liked the ls100 because it had performed well but when I looked at the US equity index this performed better.

Now I appreciate that if the US struggles vs UK and other European ones this could change but because the US is the largest economy,  I feel that any negative impact will be felt across the globe.

I also like the long term outlook of the ftse 250 and I have actually seen and worked with a couple of them and they have ambitions growth plans with plenty of room to grow. This  as a result over the last decade has wiped the floor with the ftse 100.

This may be too risky but I'm really swaying toward 50% ftse 250 and 50 us equity rather than the ls100.

I will probably start my aggressive investments at the beginning of next year so I don't have to rush into a decision. 

Tyler

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Re: Is diversification just another way of lowering returns?
« Reply #6 on: May 28, 2017, 08:32:54 AM »
Hi Jamese20.

To visualize the historical context of different UK portfolios, try these calculators:

https://portfoliocharts.com/calculators/

I recommend starting with the Heat Map, as that is a nice snapshot of more than a thousand different investing timeframes in one image.  Set the country to the United Kingdom, and that translates all numbers to GBP and UK inflation.  In that setting, "Total Domestic Market" uses FTSE All Shares data and the bonds are all based on UK Gilt funds. 

Play around with different asset allocations for a while, and I suspect you'll gain a new appreciation of the value of diversification.  It's not just about maximizing returns, but also about maximizing dependability, efficiency, and sustainability.


Jamese20

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Re: Is diversification just another way of lowering returns?
« Reply #7 on: May 28, 2017, 12:06:17 PM »
thanks tyler,

so in short you would recommend a global diverse fund with higher expense ratio? i will look at your links now, i have this year to set my decision that i hope i wont need to change in the future

Tyler

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Re: Is diversification just another way of lowering returns?
« Reply #8 on: May 28, 2017, 12:57:23 PM »
Well, it depends on the expense ratio.  ;)

In general, I'd recommend a small number of low-cost index funds chosen to build a sustainable portfolio with an appropriate risk-adjusted return for both your financial and emotional needs.  The exact funds and percentages vary by individual investor, but the principle of low-cost diversification is pretty universal. 

I do believe that international diversification is more important in other countries than many US-based investors appreciate.  While you're at it, be sure to read Monevator for some excellent UK-specific advice.

MustacheAndaHalf

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Re: Is diversification just another way of lowering returns?
« Reply #9 on: May 28, 2017, 07:41:58 PM »
Jamese20 - There's a significant flaw in your thinking.  You're assuming that the fund you pick, with the lower expense ratio, always beats the other fund.  That's not true.  Past performance isn't a prediction of future performance.  If past performance predicted the future, there wouldn't be any risk in the stock market - and you see plenty of risk and volatility, even stock crashes.  All of that is because nobody can predict either U.S. returns or international returns in the future with certainty.

You diversify so that when one area stumbles, your investments balance that out with doing well somewhere else.  If the U.S. market enters a downward slide, and you only hold U.S. stocks, you could have been using international to diversify away some of that impact.  But before it happens, you can't predict which market will do better.

Jamese20

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Re: Is diversification just another way of lowering returns?
« Reply #10 on: May 29, 2017, 12:11:37 AM »
Hi mustache,

Appreciate that, and I also expect the US is rather biased about how great their own country is regarding stocks.

I did mention that this might not be the case I'm just using this recent bull market as an example.

Also, considering the US has done the best since the stock market began in the long term then by buying a more global fund you are saying this won't be the case in the future.. Where as for the last 120+ years that's been wrong.

Feels abit like trying to out smart the market and avoid 'risk' by buying everywhere.

My main issue is why pay that extra 0.12% to have also lower returns potentially in the long term on top?

Each of the other fund historical has done very well in the long term, if it's the long game you are doing then I just don't see the logic in the diversification that people keep talking about

Retire-Canada

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Re: Is diversification just another way of lowering returns?
« Reply #11 on: May 29, 2017, 04:10:12 PM »
Also, considering the US has done the best since the stock market began in the long term then by buying a more global fund you are saying this won't be the case in the future.. Where as for the last 120+ years that's been wrong.



International stocks have done well some years. There is no way to know what will do well in the future.

Jamese20

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Re: Is diversification just another way of lowering returns?
« Reply #12 on: May 30, 2017, 01:30:40 AM »
If it had 0.10% expense ratio I'd just do it

But the return is good but still does lag behind us and ftse 250 over time

MustacheAndaHalf

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Re: Is diversification just another way of lowering returns?
« Reply #13 on: May 30, 2017, 07:43:55 AM »
Jamese20 - Your reply seems to ignore the data Retire-Canada presented.  You can also examine portfoliovisualizer for various decades to see that U.S. and international alternate.  But if you won't look at Retire-Canada's data or examples I provide, why ask for advice?

runewell

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Re: Is diversification just another way of lowering returns?
« Reply #14 on: May 30, 2017, 08:09:37 AM »
Frankly I wouldn't get too concerned about a 0.10% vs 0.20% expense ratio, both are fairly low.  If you don't want a single index, you can probably hold 2-5 index ETF's in your portfolio and not pay much more in fees. 

VOO mimics the S&P (with a 0.04% expense ratio).
VWO is emerging markets (0.14%)
VNQ is REITs (0.14%)
BLV has bond exposure (0.07%)
VT gives you all stock, both US and international (0.11%)

Whatever these LS100 funds are, I don't know why I would bother to hold with a 0.20% expense ratio when a mix of Vanguard ETF's would do nicely. 
Maybe select 10% BLV, 15% VNQ, 15% VWO, and 60% VT or replace with some VOO if you want good ole home-country bias.


Jamese20

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Re: Is diversification just another way of lowering returns?
« Reply #15 on: May 30, 2017, 02:23:39 PM »
Hi mustache

I did look at it and does provide an interesting perspective

But in over time I was thinking over the stretch of the market.

I will check yours out and take a look thanks for sharing, it is just hard to pick which fund based on so many unknowns really.