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Is this diversification worth the extra complexity?
Old 12-15-2010, 01:42 PM   #1
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Is this diversification worth the extra complexity?

I have 12 different funds at Vanguard, in part because of the different fund categories (My TIRA, My Roth, Lena's TIRA, Lena's Roth, Taxable). I'd prefer the simplicity of fewer funds.

Most of the money is in indexed stock, bond, and international funds.

In addition, in the interests of diversification, I have 3% of the total in the health care fund, 1% in the small cap value index and 3% in the small cap growth index fund. I could make things slightly simpler if I folded those into the stock index funds.

Do you think the added diversity of this 7% is worth the slight added complexity of having 12 funds instead of 9?
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Old 12-15-2010, 02:25 PM   #2
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I think they are worth it.

Historically, small cap is volatile, but can have very good gains. 4% exposure is minimal but could harvest some gains. I personally remain confident in healthcare. Though I admit the effects of healthcare reform on the market concern me. I believe baby boomers will fight aging with all the economic muscle they have.

I just read The Bogleheads Guide. They suggested keeping "sector bets," such as health care at about 5%. You are well within that guideline. I have been VERY heavy in healthcare. I am in the process of changing my portfolio to reflect said wisdom, while diversifying into some indexed stock funds.

Take my comments with a grain of salt. You are a much more experienced investor than I.
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Old 12-15-2010, 04:02 PM   #3
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I like a little extra diversity/complexity because it keeps me engaged in different parts of the market. Makes it more interesting.
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Old 12-15-2010, 05:52 PM   #4
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Originally Posted by TromboneAl View Post
In addition, in the interests of diversification, I have 3% of the total in the health care fund, 1% in the small cap value index and 3% in the small cap growth index fund. I could make things slightly simpler if I folded those into the stock index funds.

Do you think the added diversity of this 7% is worth the slight added complexity of having 12 funds instead of 9?
I am not a slice-and-dicer. I don't think that less than 5% in a fund is going to make a huge difference to your overall portfolio performance.

On the other hand, my Roth IRA which I regard as my "playground" (I guess equivalent to UncleMick's testosterone picks), is less than 1% of my portfolio and contains a couple of funds that I don't own anywhere else in my portfolio. This is where I experiment, have fun, and invest instinctually on sure things (which is why its performance has been positively abysmal compared to my more sensible main portfolio).

So, I would tend to consolidate unless these funds are also similar to UncleMick's testosterone investments, a way to get wild investment urges out of your system.
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Old 12-15-2010, 06:19 PM   #5
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Do you think the added diversity of this 7% is worth the slight added complexity of having 12 funds instead of 9
Yes, if the 3 are not subsets of the 9. Putting 7% in funds that are significantly underrepresented - like Asian small cap or emerging markets small cap would probably add enough to the upside to offset the risk and paperwork.
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Old 12-15-2010, 06:41 PM   #6
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Do you think the added diversity of this 7% is worth the slight added complexity of having 12 funds instead of 9?
The academicians who have concluded that 12 is more diversified than nine do not have to account for the "hassle factor" of tracking, rebalancing, and doing their taxes.

The average investor probably wouldn't notice the difference, but would be annoyed by having to do more housekeeping for little or no perceived benefit.

You probably wouldn't sleep better at night from the (slightly lower) volatility, and you probably wouldn't notice the (slightly higher) returns.
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Old 12-15-2010, 06:57 PM   #7
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You mention that you prefer simplicity of fewer funds so I say get 4% small cap value (value has better performance than growth) but 0% health care. Without looking at your portfolio, I say small cap value does add diversification and extra return. It's hard to say health care will add these 2 factors into your portfolio so, for simplicity sake, skip it.

Having said all that, small cap and/or health care will probably have little impact on your volatility and return.

Oh yeah, also, if you're trading these as ETFs or mutual funds, there might be trading costs as well as possibly higher expense ratio compared to your avg portfolio exp ratio.
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Old 12-15-2010, 07:05 PM   #8
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I like a small-cap- & value-tilted portfolio and would not want a total market index weighted portfolio. So my suggestion to you is to INCREASE 1% in your small-cap value fund by selling your small-growth fund.

Also to simplify, you can have one-fund per some of those accounts if that is not already the case.

At a minimum I would have the following 5 funds:

Total US Stock Market
US Small Cap Value
Total Foreign Stock Market
Foreign Small Cap
US Bond Index

If you allow yourself 9 funds, you can add a REIT fund and emerging markets (large-cap and small-cap, but your 2 main foreign funds should already have emerging markets in them), and maybe some short-term bond funds.
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Old 12-16-2010, 10:33 AM   #9
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I try to only invest in 3 funds (total bond, total stock, total international stock).

There are some exceptions (US EE bonds that haven't matured yet, for my HSA -- which I don't really used as investment, I have in balanced fund).

In the past, I thought about investing in a precious metals fund for diversity. But I wouldn't have had a large percentage so decided against it.

I prefer the simplicity.
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Old 12-16-2010, 10:42 AM   #10
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I am not a slice-and-dicer. I don't think that less than 5% in a fund is going to make a huge difference to your overall portfolio performance.

On the other hand, my Roth IRA which I regard as my "playground" (I guess equivalent to UncleMick's testosterone picks), is less than 1% of my portfolio and contains a couple of funds that I don't own anywhere else in my portfolio. This is where I experiment, have fun, and invest instinctually on sure things (which is why its performance has been positively abysmal compared to my more sensible main portfolio).
Indeed, there is a small part of my portfolio which I consider a "sandbox" for doing things I don't do with the vast majority of my portfolio. These may be individual stocks, sector plays, speculative investing and the like. If I can satisfy the occasional urges to deviate from the "norm" of asset allocation with index funds with (say) only 2-3% of my total portfolio value, it keeps the other 97-98% "safe" from exposure to risky things.
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Old 12-16-2010, 07:03 PM   #11
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I try to only invest in 3 funds (total bond, total stock, total international stock).

There are some exceptions (US EE bonds that haven't matured yet, for my HSA -- which I don't really used as investment, I have in balanced fund).

In the past, I thought about investing in a precious metals fund for diversity. But I wouldn't have had a large percentage so decided against it.

I prefer the simplicity.
I'll just say that I'm a slice and dicer. In particular, I have 5% in the Vanguard Precious Metals and Minerals fund (to cover natural resources in some way) and 9% in the Vanguard REIT fund (to cover real estate). I can say that although these two holdings are small, they have much less correlation to the general market and thus are good for diversification and reduction of risk. These two funds have performed spectacularly over the past 2 years and are a big reason that I'm back to about where I started before the crash. Of course I've rebalanced the gains back out to my other holdings.
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Old 12-16-2010, 10:15 PM   #12
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I'll just say that I'm a slice and dicer. In particular, I have 5% in the Vanguard Precious Metals and Minerals fund (to cover natural resources in some way) and 9% in the Vanguard REIT fund (to cover real estate). I can say that although these two holdings are small, they have much less correlation to the general market and thus are good for diversification and reduction of risk. These two funds have performed spectacularly over the past 2 years and are a big reason that I'm back to about where I started before the crash. Of course I've rebalanced the gains back out to my other holdings.

Do you find it difficult to rebalance the gains? For example when the Precious Metals fund has gone on a tear?

For me, I'd be afraid of giving into temptation and greed. For example, I might think "the metals has been doing so well, so I'll let it ride a little longer, more than 5% allocated". Like playing a poker hand too long
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Old 12-16-2010, 10:22 PM   #13
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Do you find it difficult to rebalance the gains? For example when the Precious Metals fund has gone on a tear?

For me, I'd be afraid of giving into temptation and greed. For example, I might think "the metals has been doing so well, so I'll let it ride a little longer, more than 5% allocated". Like playing a poker hand too long
No, it's pretty easy. I have a spreadsheet of my entire portforlio, and periodically update the current prices. It automatically changes certain cells to yellow when the current values for a particular fund go out of bounds. The criteria are as mentioned in some books - either more the 5% *absolute* difference from the target asset allocation, or more than 25% of *relative* difference to the target allocation.

Example:

I consider Precious Metals and Minerals a separate subclass. If my target allocation for this fund is 5% of my total portfolio (which it is), then I rebalance when:

- either the absolute current percent of portfolio goes outside +/- 5% of target, i.e., 0%-10% (obviously this case won't happen due to the small target value of 5%); or
- the relative value goes more than 25% off the target, i.e., 5% +/- 25% of that value, or 3.75% to 6.25%.

My spreadsheet does this calculation automatically for all of my asset classes, so I just update the values, look for yellow cells, and rebalance if necessary.
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Old 12-16-2010, 10:40 PM   #14
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I try to only invest in 3 funds (total bond, total stock, total international stock).

.............

I prefer the simplicity.
Me too - less is more.
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Old 12-17-2010, 07:09 AM   #15
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While a three-fund approach has merits (i.e., simplicity), Three-fund portfolio - Bogleheads, an addition of two more funds, e.g., REIT, Precious Metals can provide further diversification.
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Old 12-18-2010, 07:26 AM   #16
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I'm a four funder:

total stock index
small cap index
intl stock index
total bond index
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Old 12-18-2010, 09:57 AM   #17
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Unless we're talking about a massively leveraged instrument, a 1% allocation to anything seems like a waste of time, IMHO. How much diversification do you get from a 1% slice? Even in the extreme case where the 99% of the rest of the portfolio declines by 50% and the 1% slice doubles, your entire portfolio is better off by a whopping 3%. In the more likely scenario where the entire portfolio is down 20% but this slice is down only 10%, or even zero, you're better off by 13bp or 25bp, respectively. Not worth the trouble.

Also, depending on what the other funds are, some of this may reflect overweighting certain areas, rather than adding diversification. Health care, in particular, is probably represented in your other funds. It's perfectly O.K. to add exposure to that sector if you want to overweight it for some reason, but I wouldn't call this diversification. It's actually the opposite, it's concentration.
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