Jeremy Siegel's 1/3, 1/3, 1/3 diversification

[singletond]

On Squawk Box this morning Jeremy Siegel was quizzed about academic's recommending "owning the world". He said he owned 1/3 US, 1/3 emerging markets and 1/3 rest of the world.

We have 40-45% outside the US and I thought that was a lot. How common is it for Bogleheads to have around 2/3 of the portfilio outside the US?

Dave

[wesleymouch]

We just follow the allocation of the total world ETF - VT. It is about 45% North America

[nisiprius]

Burton Malkiel, author of A Random Walk Down Wall Street, describes himself as "one who has been smitten with the gambling urge since birth." I do not know whether Professor Siegel has ever commented on his own risk tolerance, but I think it is reasonable to surmise that people are attracted to the investment world because they a personal taste for risk. Thus, they are apt to be at the aggressive end of the risk tolerance spectrum, and to have "decreasing relative risk aversion." That is, they react to increased wealth by saying "Great! Now I can afford to gamble a bit," as opposed to people who say "Great! Now that I've won the game, I'll stop playing."

Knowing Siegel's constant cheerleading for stocks and, for at least the last three years, repeatedly crying "wolf!" about bonds, I assume that his personal investment allocation is 100% stocks.

I do not think there can be any serious question that his 1/3, 1/3, 1/3 allocation involves distinctly more risk than a 100% U. S. stock allocation. The additional risks of international investing in general and emerging markets in particular are acknowledged in every prospectus, and Vanguard puts their international funds in risk potential category 5, whereas Total [U.S.] Stock Market Index is in category 4.

Certainly, a sane person could judge that it is a calculated risk and that they are willing to take it in order to increase their chances of reward. As for diversification, it might make the total risk of the portfolio less risky than the sum of the risk of its parts, but it is not credible that the diversification effect would make such a portfolio safer; I am sure Professor Siegel did not claim that. Even the most casual glance at the behavior of Vanguard
Total Stock,
Total World,
[International] Developed Markets, and
Emerging Markets during 2008-2009 makes this clear. The global diversification of the Total World fund did not reduce the size of the drop, and overweighting Emerging Markets would only have made things worse.



It's not a huge amount of extra risk, but it's more risk, not less. It may well have a better reward-for-risk relationship, but, again, it is more risk, not less.

In short, Professor Siegel's portfolio sounds quite suitable for someone with a secure tenured academic job, probably a decent chunk of wealth from royalties and his consulting at WisdomTree, and decreasing relative risk aversion."

DId he say that it was a suitable model for everyone?

[Call_Me_Op]

I suspect few Bogleheads have 2/3 in non-US equities. I have 50% in non-US and 25% in EM, and that is toward the high end. But I do not hold anywhere near 100% of my portfolio in equities, so I tilt because my equity allocation is on the low side.

[larryswedroe]

IMO good starting place is how world allocates capital. Then have small home bias because international investing is bit higher costs and bit less tax efficient. That would argue for 50% US and 50% international (which is what I recommend). Then the other 50% is about 3:1. So say 37.5% developed and 12.5% EM.

EM has lower correlation and higher expected returns so you might want to consider tilting, but recognizing the risks

Hope that helps
Larry

[pkcrafter]

The big allocation to EM smacks of recency bias.

Nisiprius wrote:

Burton Malkiel, author of A Random Walk Down Wall Street, describes himself as "one who has been smitten with the gambling urge since birth." I do not know whether Professor Siegel has ever commented on his own risk tolerance, but I think it is reasonable to surmise that people are attracted to the investment world because they a personal taste for risk

.
That would be an interesting topic for a new discussion.

Paul

[KyleAAA]

I have 50/50 US/foreign equities; however, about 40% of my foreign equities are in emerging markets (about 20% of total equities, or double the global market weight). So I guess you could say I have a high risk tolerance.

[dbr]

A really good asset allocation plan is the 1/N scheme. Figure out what the asset classes are you think you want. Count how many you came up with, N. Allocate 1/N to each.

[G-Money]

A really good asset allocation plan is the 1/N scheme. Figure out what the asset classes are you think you want. Count how many you came up with, N. Allocate 1/N to each.

Agreed. I've tinkered with different percentages, but it's hard to beat equally dividing up asset classes for simplicity. For me, managing 5 or even 10% slices seemed to be more trouble than it was worth.

I also appreciate the naivety of equal weighting. Using more precise percentages implies that the optimal portfolio is knowable in advance. I don't believe that it is.

[EternalOptimist]

I have roughly 15-20% of my equities in international. My gut says the US is a better place for me.

[nisiprius]

A really good asset allocation plan is the 1/N scheme. Figure out what the asset classes are you think you want. Count how many you came up with, N. Allocate 1/N to each.

I can't tell if that's ironic or not.

The obvious problem: what counts as an asset class?

Plan X:

1/7 stocks
1/7 corporate bonds
1/7 Treasury bonds
1/7 Treasury notes
1/7 Treasury bills
1/7 TIPS
1/7 international bonds

Plan Y:

1/7 small-cap value stocks
1/7 REITS
1/7 emerging markets stocks
1/7 consumer staples stocks
1/7 dividend stocks
1/7 Pacific mid-cap growth stocks
1/7 bonds

Plan Z:
1/7 stocks
1/7 bonds
1/7 collectible Beanie babies
1/7 Pez dispensers
1/7 Thomas Kinkade, Painter of Light® Master Highlighted pictures
1/7 Bradford Exchange Thomas Kinkade, Painter of Light® genuine limited edition ceramics, without wind-up mechanisms
1/7 Bradford Exchange Thomas Kinkade, Painter of Light® genuine limited editions ceramics, with wind-up rotating mechanisms

[BBL]

nisiprius » Fri Feb 08, 2013 12:08 pm

dbr wrote:
A really good asset allocation plan is the 1/N scheme. Figure out what the asset classes are you think you want. Count how many you came up with, N. Allocate 1/N to each.I can't tell if that's ironic or not.

I'm fairly certain it was a sarcastic reference to 'naive diversification'. I could be wrong.

[Browser]

Higher risk should = Higher returns (eventually) IF you can handle the consequences of the risk part AND can wait long enough for eventually to happen.

[RenoJay]

Plan Z:
1/7 stocks
1/7 bonds
1/7 collectible Beanie babies
1/7 Pez dispensers
1/7 Thomas Kinkade, Painter of Light® Master Highlighted pictures
1/7 Bradford Exchange Thomas Kinkade, Painter of Light® genuine limited edition ceramics, without wind-up mechanisms
1/7 Bradford Exchange Thomas Kinkade, Painter of Light® genuine limited editions ceramics, with wind-up rotating mechanisms

Done and done. I just sent my broker the buy order for the Kinkade pictures. He said the ask/bid spread on beanie babies was unusually wide and suggested we wait til Asian markets open so there'd be more liquidity.

[dbr]

nisiprius » Fri Feb 08, 2013 12:08 pm

dbr wrote:
A really good asset allocation plan is the 1/N scheme. Figure out what the asset classes are you think you want. Count how many you came up with, N. Allocate 1/N to each.I can't tell if that's ironic or not.

I'm fairly certain it was a sarcastic reference to 'naive diversification'. I could be wrong.

Of course it's sarcasm. It drives me nuts when these guru's present these 1/N recommendations as if there is some profound meaning to be expressed in them. I have no problem with Siegel making an argument for more or less allocation in some direction or another, but expressing that in kindergarten drawings like that is an insult to people's intelligence.

Anyway, as everyone knows, asset allocations must always be in prime number percentages and 33 is not prime; 3 x 33 does not add to 100 either. None of the integer divisions of 100 bigger than 5%, namely 50, 25, 20, and 10 are prime anyway so the 1/N scheme is proven to be impossible to implement. Even worse the numbers of asset classes that can follow 1/N and add to 100 are 1, 2, 4, 5, 10, 20, 25, 50, and 100, so one is quite challenged to identify exactly the right number of asset classes to complete the scheme even without primes.

I'm going skiing.