The Downsides of Diversification
The Downsides of Diversification
On the difficulties of diversification and why even the best portfolio still loses money sometimes.
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We are always "losing money" in this sense unless we are buying and selling the optimal assets every day. Even their example of the "winning" S&P 500 is still just an index scooping up all the big losers along with all the big winners. We diversify because we can't pick the winning assets every time, so if you understand the benefits of diversification I feel like the drawbacks are already obvious.
I think this is more of a challenge of psychology. You need to mentally flip red numbers from "losses" to that asset class "being on sale".
Let me explain:
- In the long run, all asset classes will see gains. We know this.
- The price of assets only matters when you buy or sell.
- We know that different asset classes are partially uncorrelated—in fact, the less correlated the better.
Take those three points together and you'll realize that rebalancing a portfolio to sell off "winners" to buy "losers" is actually optimal. In the long run, the asset classes will see their average long-term returns, but when you rebalance, you're always selling high and buying low. And those assets you pick up "on sale" will, on average, outperform.
The less popular view I have is to keep 0% cash and 0% bonds on long investment horizons, which means all retirement funds. Even when you retire, you still will be drawing down for a long time. Long enough for stocks to outperform.
You miss the point of „Costs of missed opportunities“ if you (a) are always fully invested, (b) keep even underperforming stocks/assets forever until (c) some of those may go bankrupt.
Same with other assets.
Btw the price if assets matter if you buy. Not if you sell, this is a pure bet on raising prices. One should have an idea how much an asset can raise in price. (Or would you buy a property right now, because price will raise anyway?)
When we're talking about asset categories, then the assumption is that we're talking about the full market. Sure , a company can go bankrupt, but an asset class can't. If the S&P500 "goes bankrupt" then money is worthless anyway.
Also not sure what you mean about price not mattering when you sell... The price you sell it for less the price you paid for it is literally the return on investment. They're the only two prices that matter.
And re: keeping an underperforming asset class forever I'm in complete agreement. That's why I said not to hold cash or bonds. Both those asset classes will underperform forever. If you aren't fully invested then, in average, you're losing out on the average gains if the asset class.
I think you might be alluding to timing the market? In that case you're "speculating", not "investing". Speculation is making a(n educated) guess about market directions. Investment is earning an expected return over time on capital.
I think you might be alluding to timing the market? In that case you're "speculating", not "investing". Speculation is making a(n educated) guess about market directions. Investment is earning an expected return over time on capital.
That might actually my different view point.
I think one should time the market or even trying to do so. There aren’t always good times. I mean that thing of „time in market beats market timing“ is for buy&forget investors who don’t want to put much effort in their finances. If you care, you see which area is a go and which a no-go at a certain moment in time.
That speculating vs investing is well written. I‘m not a native English speaker and put both under the umbrella of „Investor“ - who actually does both. So for me „speculating“ is key when you buy a stock or asset.
Having, even a rough, idea of how the price is and how it might move should be essential. And with this mindset the price of buying is important only. Because you won’t buy a going to decrease asset, would you? Charles Munger and all those other value investors are doing it like this.
Sure. But why not just staying with SP500? It gives more returns and, to a high degree, is to big to fail. Central banks will intervene before the money burns.
- If safety is your reason for diversification, think about the central banks.
- If returns is your reason for diversification, think about market share of US economy and SP500 returns.
From August 2012 to mid-November 2023, my portfolio returned 7.6% annually or 4.8% per year after inflation. This is above my long-term return expectation of 4% per year after inflation for a diversified portfolio. However, it’s still far below what U.S. stocks returned over this same time period. From August 2012 to mid-November 2023, the S&P 500 returned 13.1% annually or 10.2% per year after inflation.
For me, asset diversification seems to be the game of millionaires to stay rich. For getting wealthy for standard people growth stocks seem to be the best way.