Why Not A Diversified Portfolio?

Every investment advisor will recommend that you diversify your portfolio in order to reduce risk.

What Is A Diversified Portfolio?

What About Gold In Your Diversified Portfolio?

Not All That Glitters Is Worth Owning, Especially Gold

The chart below needs no explanation.

Gold vs CPI vs S&P500 chart

Why A Diversified Portfolio>?

Why Not A Diversified Portfolio? Here’s Why…

  1. Diversified portfolios do not reduce “risk”. EXPLAIN
  2. Diversified Portfolios do not perform any better over the long run than a single fund that tracks the S&P 500 . EXPLAIN!

    • Higher costs of a diversified portfolio reduce performance potential. EXPLAIN!
    •  A 100% Equity Portfolio beats Diversified Portfolio Every Time EXPLAIN!
    • On-line broker, Fidelity, shows that diversification does not match S&P500 performance. EXPLAIN.
  3. There are no benefits to a Diversified Portfolio when the investment horizon is 50+ years as it is with The Plan. EXPLAIN
  4. Diversified Portfolios are difficult to construct. EXPLAIN!
    • Unless you are very confident about your investment skills, you will need an investment advisor if you insist on a diversified portfolio. This will cost you a lot of money. EXPLAIN
  5. Diversified portfolios are difficult to maintain. EXPLAIN!
  6. Owning only a fund that tracks the S&P500 is guaranteed to capture all “the market” has to give. EXPLAIN!

  7. Owning only a fund that tracks the S&P500 entails less risk than owning a diversified portfolio. EXPLAIN
  8. A Theroretical Proof that debunks the “diversify” advice:
    On The Principle of Diversification and Risk; A Contrarian View

Conclusion

The objective  of the Investing For Retirement investor is to have as much money during retirement as possible. Having a Diversified Portfolio does not improve the chances that there will be more money at beginning of the retirement period.

As shown above, it is most likely that there will be less money from a diversified portfolio than from a portfolio consisting of only VTI.

Diversified Portfolio Definition

Diversifed Portfolio.

Beware the “You Must Diversify” Mumbo Jumbo

Wealthfront is an online investment management company that says this about itself:

Wealthfront is reimagining how people invest their money

By building an automated investment service from the ground up to put the client first, Wealthfront is paving the way for a new generation of investors to achieve their financial goals. We believe this is a once-in-a-generation opportunity to change an industry and build something new, something different, something better.

Wealthfront makes it easy for anyone to get access to world-class, long-term investment management without the high fees or steep account minimums

They invoke all the important sounding concepts in their marketing

  • We use Modern Portfolio Theory (MPT) to identify the ideal portfolio for each client. The economists who developed MPT, Harry Markowitz and William Sharpe, received the Nobel Prize in Economics in 1990 for their groundbreaking research.
  • We also evaluate each asset class on its potential for capital growth and income generation, volatility, correlation with the other asset classes (diversification), inflation protection, cost to implement via ETF and tax efficiency.
  • Wealthfront determines the optimal mix of our chosen asset classes by solving the “Efficient Frontier” using Mean-Variance Optimization (MVO).
  • MVO requires, as inputs, estimates for each asset class’s standard deviation, correlation and expected return.
  • To estimate each asset class’s expected returns, we start with the Capital Asset Pricing Model (CAPM) (Sharpe, 1964) as the baseline estimate.
  • … tax-loss harvesting
  • Efficient Frontier

The whole white paper, “Wealthfront Investment methodology White Paper”  can be read HERE.

The chart below says it all.

Callan Periodic Table 1996 - 2015, S&P 500 highlighted

 Explanation

  • Each of the 10 colors in the above chart represents one type of asset in a “diversified” portfolio.
  • The type of security and the annual gain/loss is shown in each colored block and reproduced in the table that can be accessed by clicking HERE
  • Each column represents one year; twenty years of data are represented in the chart.
  • The yellow line tracks the annual percent gain/loss of the S&P 500.

After 20 years (1996-2015) the average annual gain of the S&P 500 is 10.39% versus 9.46 for the diversified portfolio of 10 “diversified” assets.

Conclusion

To summarize, in any given year, some of the diverse funds will do better than S&P500, some will do worse. Over the years, these random variations around the S&P 500  trend line will sum to zero meaning that a diversified portfolio will not outperform the S&P 500, nor will it reduce your overall risk over a horizon of 20 years or more.

If, after 20 years, the average return of a diversified portfolio is less than the average return of the S&P 500, there is no reason to invest in anything other than a fund that merely tracks the S&P 500. This superior performance holds for all time periods greater than 15 years.

The data that supports the conclusion can be seen by clicking on this link: S&P vs Callan Diversified Portfolio.

In 2008, the year when the market lost OVER half its value at one point, the diversified portfolio of 10 securities lost 32.5%, the S&P lost 37% of its value. Missing out on the superior overall performance of the S&P 500 is a high price to pay just to lose a little less in the worst market in 80 years.

The “Investing For Retirement” Position

We do not believe that any one who is Investing For Retirement needs to have a diversified portfolio during the active “accumulation” stage of the accumulate/withdraw stages. In fact, having a diversified portfolio is actually contrary to the Investing For Retirement investor’s best interest.

Portfolio Performance

But it turns out, that with all their attention to modern portfolio theory, the “Investing For Retirement’ recommendation – “just buy VTI and nothing else” outperformed the scientifically derived Wealthfront portfolio  by a factor of 150% over the ten year period, 1/31/2007 – 11/16/2017.

Proof of this outcome is presented in THIS spreadsheet.

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