Diversification does it work??

[RetiredAt55.5]

Not picking on anyone in particular, but one of life's little mysteries for me is understanding people who first allocate a "safe" fixed income amount and then charge off in all directions adding risk by chasing yield. Junk, emerging markets, various financial contraptions designed to enrich their sellers, etc.

+1

Its not like Vanguard doesn't warn investors about it's high yield bond fund -

https://investor.vanguard.com/529-plan/profile/4524

"The portfolio could be a good fit for college savers with a long-term savings goal who already own a diversified bond portfolio. Investors should be comfortable with the ups and downs that come with investing in high-yield bonds, which can be similar to those of the stock market."


Edit: I realized that bond fund is for 529 accounts. The regular Vanguard High Yield Corporate bond fund has similar verbiage.

 

[Freedom56]

If I look at intermediate term investment grade (VFIDX) versus the sp500 fund (VFIAX), the sp500 easily wins. Here is the chart from 1994 to present:

I don't have a suitable chart for CD's. Do you?

$10K invested in fixed income (CDs) compounded at 6.5% since 1990 would be would be $66K today with no market risk. Keep in mind, 5 year jumbo CD rates started 1990 at 9% and were 7% in 2000. Investment grade corporate bonds yielded more. You will never see a chart comparing CDs or treasuries with broad market funds because equities would look horrible compared to returns from a portfolio of CDs or individual bonds. If you compare CDs to sector funds like energy of even financials, the results are even more alarming. Consider that many financial stocks are trading below their 2007 highs and many blue chip technology stocks are still below their March 2000 highs. This myth that you should buy and hold equity funds and bond funds is perpetrated by Wall Street who want to collect fees whether they win or lose. In 2010, Fidelity changed the fund symbols of many of their funds and reset the time to zero so that their performance would look great. Other fund managers did the same thing. Right now what is alarming with equities is that many trillion dollar (or near trillion dollar) market cap companies in the broad market are holding up sectors that are nearly wiped out (energy, retail). This is not sustainable. Amazon is a good company, but it is still in a low margin retail business. Why should it trade at 82 time earnings? When those trillion dollar market cap bubble stocks fall, people will go back to basics.

 

[Which Roger]

At its root, diversification is owning different assets that have lower correlation, not simply stocks vs bonds. If you own some stocks and some bonds that tend to behave like stocks, you're not diversified.

 

[Lsbcal]

$10K invested in fixed income (CDs) compounded at 6.5% since 1990 would be would be $66K today with no market risk. Keep in mind, 5 year jumbo CD rates started 1990 at 9% and were 7% in 2000. Investment grade corporate bonds yielded more. You will never see a chart comparing CDs or treasuries with broad market funds because equities would look horrible compared to returns from a portfolio of CDs or individual bonds. ...

From the start of 1990 through the end of 2019 the SP500 CAGR was 9.9%.

I think you are making a good point about CD's doing very well in that period. I am not sure how they will do going forward as one was riding a one way trip to extremely low yields now.

I doubt that CD's came anywhere near beating a broad stock fund like the SP500.

 

[Truckinalong]

Right, it always comes down to some degree when you get in and out. CD's from here with rates at 0%. I am skeptical, that said I am an idiot this week and lost money violating all my own buy and hold rules.

 

[OldShooter]

$10K invested in fixed income (CDs) compounded ... When those trillion dollar market cap bubble stocks fall, people will go back to basics.

For someone who doesn't buy equities you are certainly quite extensively equipped with opinions that you state as facts. Remember the old rule: You are entitled to your own opinions but not to your own facts.

Now tuning out .... Not interested in your opinions.

 

[Freedom56]

From the start of 1990 through the end of 2019 the SP500 CAGR was 9.9%.

I think you are making a good point about CD's doing very well in that period. I am not sure how they will do going forward as one was riding a one way trip to extremely low yields now.

I doubt that CD's came anywhere near beating a broad stock fund like the SP500.

After the last financial crisis, I shifted from CDs to corporate notes to get better yield. My CDs only yield 3.1 to 3.2% with maturities in 2021 and 2022. I have been buying corporate notes over the past week and a half at fire sale prices well below par at yields I haven't seen since the 2008/9 financial crisis. I only invest in stable technology, telecom, pharma, healthcare, and financial companies. I avoid speculative companies as well as cyclical ones. I am only buying 1-5 years out and the yields have been pretty good and well above prevailing CD rates. My longest maturity is now 2031. At this point, I am not going to risk a 30% drop in an 8 figure portfolio in a passive equity or bond fund. A bond fund does not eliminate market risk. Carefully buying individual corporate notes and CD takes the market risk out of my portfolio. Actively managing my portfolio (selling before maturity) also mitigates potential financial risk due to financial events.

 

[Freedom56]

So much for diversification...Some facts for those who care about equities.

These 6 companies now represent 22% of the weight of the S&P 500

Microsoft
Apple
Amazon
Facebook
Berkshire Hathaway
Google

https://www.slickcharts.com/sp500


There are more funds than stocks bidding up a few companies and creating this massive distortion in the S&P 500.

 

[BeachOrCity]

For stocks and bonds I would say that it worked for me because my bond allocation was heavily tilted to government insured products of limited duration. The duration being low was bc there was little term premium.

Anyway, just like in 2008 other sectors I am diversified in are taking a huge hit. Mostly commercial real estate. That’s probably where I will have the biggest losses. But they have not been realized yet I know they are coming

 

[audreyh1]

So much for diversification...Some facts for those who care about equities.

These 6 companies now represent 22% of the weight of the S&P 500

Microsoft
Apple
Amazon
Facebook
Berkshire Hathaway
Google

https://www.slickcharts.com/sp500

There are more funds than stocks bidding up a few companies and creating this massive distortion in the S&P 500.

That’s just one sector. Not all of us owning equities are invested in S&P500 directly or only in the S&P500 which represents large cap stocks. Many of us own mid caps, small caps, international, REITs, etc. and that’s just for the equity portion, we also own fixed income including cash, and perhaps even different durations of bonds.

So I’m not sure why you are trying to convince people that they aren’t reasonably diversified.

 

[big-papa]

That’s just one sector. Not all of us owning equities are invested in S&P500 directly or only in the S&P500 which represents large cap stocks. Many of us own mid caps, small caps, international, REITs, etc. and that’s just for the equity portion, we also own fixed income including cash, and perhaps even different durations of bonds.

So I’m not sure why you are trying to convince people that they aren’t reasonably diversified.

+1
Diversification guarantees you nothing in the short term. Even if the assets you hold have nearly 0 correlation over the long term, in shorter timeframes they can indeed move together. Many people ignore that fact when they happen to move in the same direction and that direction is positive, but then freak out if they happen to go down together. 0 long term correlation means that at any given time they can move together (in either direction) or in opposite directions. Though sometimes there are some trends that can happen, but are by no means guaranteed to happen. For example, I hold intermediate treasuries. Long term correlation to stocks is nearly zero. However, during the last few recessions, when stocks took a dive, treasuries went positive. And they are doing so during this crisis as well. This is not guaranteed to happen, but I'm glad that it is again. As you might imagine, once a crisis is over, they often suffer a loss. I can live with that.

There are many different types of diversification. Within stocks, one can diversify across geographies, size, sectors, value, growth, etc. Within cash, there is cash, CD's, Money Markets, Treasuries, inflation protected bonds, as well as geography. Then there are alts, gold, other precious metals, directly held real estate, etc. Then there is time diversification for those who use some sort of systematic tactical asset allocation.

In the long term, yes, diversification works. The price to be paid for lower volatility is possibly lower long term returns.

For the mathematically inclined, there's even a metric somebody concocted to calculate the amount of diversification in a portfolio which is helpful for comparing two portfolios. It's called the Diversification Ratio (R). It's the weighted average of the sum of the standard deviation of each asset in your portfolio all divided by the standard deviation of the total portfolio, all measured over the same, long timeframe.

https://www.allaboutalpha.com/blog/2011/03/27/the-most-diversified-portfolio/