CONFLICTING ADVICE 4: DIVERSITY
We use this topic to demonstrate why you get conflicting advice and how to selectively choose the data which "proves" your point.
1. YOU WANT TO PROVE THAT EVEN THE SIMPLEST DIVERSITY PAYS OFF: Chart 1 compares a portfolio which is 100% stocks (S&P 500, VFINX) with a standard 60-40 stock bond portfolio (VBINX). We see the white line (VBINX) is a lot less volatile even in the bad times of 2000-2002 and 2008-2009 and you end up with similar portfolio values. If you could smooth out those blips in 2002 and 2008 with more diversity you would be even better off. Problem: Neither portfolio produced good numbers. Average annual return is about 7.4%. The recessions took a toll on both approaches with long periods of zero return. |
2. YOU WANT TO PROVE THAT TIME-DIVERSITY (MARKET TIMING, TACTICAL ASSET ALLOCATION, ETC) PAYS OFF: Chart B compares VBINX with our SAA100 portfolio- either 100% stocks or 100% bonds based on 200 day simple moving average.) The red SAA100 line shows even more stability and an additional 2% average annual return! Problem: In 2018 we may have entered the Great Stagnation after 8 years of bull market. SAA100 is flattening out as it buys and sells unnecessarily in a stagnating market.
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NOW LET'S PROVE THE EXACT OPPOSITE WITH A DIFFERENT SET OF CHARTS BY CHANGING DATES
3. YOU WANT TO PROVE THAT DIVERSITY INTO BONDS SIMPLY COSTS YOU MONEY WITH NO BENEFIT: Chart C compares a 100% stock portfolio (VFINX) with balanced (VBINX) since 2009. Start with $10,000. VFINX is worth $49,710. VBINX is worth $32,710. Your diversity has cost you $17,000 with no benefit. Problem: Unless recessions are a thing of the past, VFINX will drop 50% at some point and your VBINX fund will again look pretty good.
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4. YOU WANT TO PROVE THAT TIME-DIVERSITY (MARKET TIMING) IS BOGUS : Chart D adds our market timing portfolio SAA100 to Chart C. During 2000-2010, market timing worked well for SAA100 as the stock market had two 50 percent drops and recoveries. In contrast, from 2009 on in a bull market, ill-timed selling and rebuying of stock costs SAA100 money. Problem: Unless recessions are a thing of the past, stocks will fall 50% someday but SAA100 will again sell high and buy low. At the end of the recession SAA100 will be the winner even starting at 2009.
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There you have it! In certain periods, stock/bond diversity (VBINX) smooths out the ups and downs but doesn't improve returns and market timing (SAA100) smooths and improves returns. But in bull markets, diversity just reduces returns.
You would like to find some simple compromise such as VBINX (balanced 60-40) where you sacrifice some returns but sleep better but then you encounter the following : in an 8 1/2 period in 2000-2010 (8/31/00 to 3/31/09) VBINX made no money ($10,000 invested in VBINX on 11/30/1992 was worth $27,781.72 on 8/31/00 and was worth $26,834.97 on 3/31/09). During the same period a money market fund was paying 5% with no risk.. Even worse, bonds which delivered yielded over 6% in the 2000-2010 period are currently yielding just over 1% (intermediate bond ETF IEF for example).
Will more diversity help? Should you add real estate, commodities,gold,emerging market stocks and bonds,different stock sectors to your investments? Given the ambiguous charts above, it's hard to believe one can establish that taking 5% out of the stock market and putting it in commodities is beneficial.
However, we provide four more pages addressing diversity. First, Diversity Study: Three Examples is a set of model portfolios from brokerage houses showing the results from increasingly diverse portfolios. The second page, Diversity Study: AAA looks at "Adaptive Asset Allocation", a market timing portfolio drawing on 10 diverse assets and an algorithm intended to both deliver above-average returns and a smoother less volatile chart (goals claimed by those advocating a more diverse portfolio.) The third page, Diversity Study: The IVY Portfolio, looks at a well-known 5 fund market timing portfolio. The fourth page is Simple Asset Allocation, SAA100 which is either 100% VFINX or 100% FADMX (bond blend) (hence the "100" on SAA100). The decision is made at the end of each month based on VFINX price relative to its 200 day simple moving average.
You would like to find some simple compromise such as VBINX (balanced 60-40) where you sacrifice some returns but sleep better but then you encounter the following : in an 8 1/2 period in 2000-2010 (8/31/00 to 3/31/09) VBINX made no money ($10,000 invested in VBINX on 11/30/1992 was worth $27,781.72 on 8/31/00 and was worth $26,834.97 on 3/31/09). During the same period a money market fund was paying 5% with no risk.. Even worse, bonds which delivered yielded over 6% in the 2000-2010 period are currently yielding just over 1% (intermediate bond ETF IEF for example).
Will more diversity help? Should you add real estate, commodities,gold,emerging market stocks and bonds,different stock sectors to your investments? Given the ambiguous charts above, it's hard to believe one can establish that taking 5% out of the stock market and putting it in commodities is beneficial.
However, we provide four more pages addressing diversity. First, Diversity Study: Three Examples is a set of model portfolios from brokerage houses showing the results from increasingly diverse portfolios. The second page, Diversity Study: AAA looks at "Adaptive Asset Allocation", a market timing portfolio drawing on 10 diverse assets and an algorithm intended to both deliver above-average returns and a smoother less volatile chart (goals claimed by those advocating a more diverse portfolio.) The third page, Diversity Study: The IVY Portfolio, looks at a well-known 5 fund market timing portfolio. The fourth page is Simple Asset Allocation, SAA100 which is either 100% VFINX or 100% FADMX (bond blend) (hence the "100" on SAA100). The decision is made at the end of each month based on VFINX price relative to its 200 day simple moving average.