3 Fund - should it be more diversified?

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DontTimeIt
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3 Fund - should it be more diversified?

Post by DontTimeIt »

I'm sure there will be people on many sides of this loaded question, so I hope I'm not asking anything too offensive. I currently have a 3 fund portfolio and am working though my IPS.
Before I write in stone about only using three funds, I was wondering if there are other areas I should consider. What is the benefit of only keeping three funds and having a lot of diversification, but maybe not as much as can be had if Commodities and REITs were also included - those two areas come to mind, though I'm sure people here could suggest others.
If a goal is to be diversified, manage risk and earn a reasonable rate of return, should someone be encouraged to educate themselves on ways to diversify more, outside of the three fund portfolio, or are there reasons opposing such diversification.
Thank you
boglephreak
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Re: 3 Fund - should it be more diversified?

Post by boglephreak »

something to consider:

- Small Cap Value
- REITs
- International Bonds
- TIPS

I am currently looking at SCV and determining whether I want to do it, but have not decided. I do not like REITs and wont go there (I currently have a lot of my net worth in rental properties). keep in mind that total U.S. stock market has REITs and SCV, so you arent adding diversification, you are adding a tilt towards an asset class you feel will overperform. I do not like International Bonds and wont go there as I believe U.S. bonds are sufficient (and I am also only at 10% bonds in my portfolio so any change would be meaningless).

I wouldnt even think about commodities; its not even worth my time.

Taylor is going to come in here and tell you some combination of the enemy of a good portfolio is a perfect portfolio, and diversification for the sake of diversification is the devil. I tend to agree with him. a three fund portfolio with a possibility of a SCV tilt in the future is all i need.
Slacker
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Re: 3 Fund - should it be more diversified?

Post by Slacker »

DontTimeIt wrote:I'm sure there will be people on many sides of this loaded question, so I hope I'm not asking anything too offensive. I currently have a 3 fund portfolio and am working though my IPS.
Before I write in stone about only using three funds, I was wondering if there are other areas I should consider. What is the benefit of only keeping three funds and having a lot of diversification, but maybe not as much as can be had if Commodities and REITs were also included - those two areas come to mind, though I'm sure people here could suggest others.
If a goal is to be diversified, manage risk and earn a reasonable rate of return, should someone be encouraged to educate themselves on ways to diversify more, outside of the three fund portfolio, or are there reasons opposing such diversification.
Thank you
The three fund portfolio is already diversified (other than outright owning commodities and international bonds). I believe you are discussing tilting your portfolio to be over-representative of sectors of the market (e.g. VTI has REITs, a separate allocation to REITs tilts your portfolio more heavily in that direction).
Pale Horse
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Re: 3 Fund - should it be more diversified?

Post by Pale Horse »

Diversified? How much more diversified can you get beyond owning 10,000 unique companies and 8,500 bond positions? I'd say that's fairly diversified.
bloom2708
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Re: 3 Fund - should it be more diversified?

Post by bloom2708 »

The only thing missing from the 3 fund is "all the international bonds". The bond indexes can't hold "all" the different bonds, but a very broad cross-section.

Tilting to XYZ is actually the opposite of "more diversified" or at least the "same" diversification.

If you own the Total US stock market and then buy a small cap value fund next to it. You have the same diversification (same number of stocks). You just own more of the small cap value stocks.
"We are here to provoke thoughtfulness, not agree with you." Unknown Boglehead
AlohaBill
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Re: 3 Fund - should it be more diversified?

Post by AlohaBill »

Dear don't,
This is just an asset allocation question and although it may seem important, it really isn't. One thing that is more important is the intestinal fortitude to stick to your plans through good times and bad. However, the single most critical decision in investing is determining how much you are going to invest each paycheck. You can put $50 a month in the world's greatest stock, but you probably will make more by an increasing investment in Vtinx over the years.
However, if you want a discussion, then text about asset allocation. This discussion is never ending and fun! It is ,however, a complication.
Aloha Bill
PandaBear
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Re: 3 Fund - should it be more diversified?

Post by PandaBear »

You want a more diversified portfolio than 3 fund? I think the only thing missing is international bond. You could add that.
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Toons
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Re: 3 Fund - should it be more diversified?

Post by Toons »

3 funds are Very sufficient.
You really don't "Need"any more.
:D
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee
Theoretical
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Re: 3 Fund - should it be more diversified?

Post by Theoretical »

Honestly, this question only be answered by how you define diversification as an investor, and what your concerns are overall. Swedroe (Strict factor model, risk-parity, low beta), Ferri (Factor-based, weightings to mimic private equity and real estate consistent with the public & price equity markets), Robert T (factor-loadings target, assess risk and pursue cost-effective Slice and Dice), and Larimore/Bogle (simplicity and costs are overriding critical factors to ensure returns) ALL have their merits.

The main common thing that I would say applies to both slice and dice and total market investors is that I think significant arguments can be made that cap weighting is the right index design for an individual market/nation but that cap weighting across countries is diversified in the strict finance sense but ignores the realities of country concentration, political, economic and currency factors. I think this has merit when talking about Emerging markets (~50 in two Chinas) and concentrations in relatively few countries.
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new2bogle2
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Re: 3 Fund - should it be more diversified?

Post by new2bogle2 »

PandaBear wrote:You want a more diversified portfolio than 3 fund? I think the only thing missing is international bond. You could add that.
Things like Commodities wouldn't count as further divqersifying? Would that count as tilting? Are REITs tilting? And this isn't rhetorical, I'm genuinely curious.
Thanks
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patrick013
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Re: 3 Fund - should it be more diversified?

Post by patrick013 »

DontTimeIt wrote: If a goal is to be diversified, manage risk and earn a reasonable rate of return, should someone be encouraged to educate themselves on ways to diversify more, outside of the three fund portfolio, or are there reasons opposing such diversification.
My favorite adjustment to the 3-fund :

VBTLX - Total Stock Market Index
VTMGX - Developed Intl Stock ex-USA Index
VEMAX - Emerging Markets Stock Index
VSCSX - ST Corp Bond Index
VFIDX - Intermediate Investment Grade Bonds

Basically splits international into 2 categories and weighs corp
bonds heavier in ST to provide better liquidity at a better price if/when
rate spikes start to appear.

Others ? The usual REIT's, Utilities, High Yield Dividend, Small Cap,
Value Index, etc.. Those 10% tilts are somewhat common.
age in bonds, buy-and-hold, 10 year business cycle
xjz
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Re: 3 Fund - should it be more diversified?

Post by xjz »

new2bogle2 wrote:Things like Commodities wouldn't count as further divqersifying? Would that count as tilting? Are REITs tilting? And this isn't rhetorical, I'm genuinely curious.
Thanks
REITs are just a class of publicly traded companies. If you're investing in something like Vanguard's total domestic stock fund, you're already exposed to REITs according to their market cap in the public sector, which happens to be extremely small (something like 3%, I think?).

You can choose to add a REIT fund in addition to a total market fund if you feel that REITs are, for whatever reason, more valuable than the average publicly traded company. But note that (at least according to Wikipedia) the definition of diversification is "the process of allocating capital in a way that reduces the exposure to any one particular asset or risk". By weighting REITs above their market representation, you are doing exactly the opposite - you are increasing your exposure to a particular market sector and its associated risks and rewards. This is tilting, not diversification.
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patrick013
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Re: 3 Fund - should it be more diversified?

Post by patrick013 »

xjz wrote:This is tilting, not diversification.
You are absolutely right. And people keep reading analyses that
say REIT is higher quality than individual Real Estate, Utilities are
low-beta high payout defensive stocks, High Yield Dividend pays
more than bonds with lower risk than other stocks, and small cap
and value stocks have age old factor benefits.

Also, anything over 500 stocks in any index can actually water that
index down. Lesser quality stocks are allowed in the index and the
effect could be a lower total return due to overdiversification.
age in bonds, buy-and-hold, 10 year business cycle
xjz
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Re: 3 Fund - should it be more diversified?

Post by xjz »

patrick013 wrote:You are absolutely right. And people keep reading analyses that
say REIT is higher quality than individual Real Estate, Utilities are
low-beta high payout defensive stocks, High Yield Dividend pays
more than bonds with lower risk than other stocks, and small cap
and value stocks have age old factor benefits.
Right, I don't mean to imply that tilting is bad or unworthy of consideration. It is simply a different strategy, different from the one espoused by the core Bogleheads investment philosophy (which encourages diversification and simplicity).

Tilting is an option, and many investors do it; but it is not diversification, and justifying their inclusion on the basis of diversification (as the OP suggests, for example) is a mistake.
patrick013 wrote:Also, anything over 500 stocks in any index can actually water that
index down. Lesser quality stocks are allowed in the index and the
effect could be a lower total return due to overdiversification.
I don't quite understand how "overdiversification" is a problem. The market prices stocks based on expectation of their value; if the market is efficient at doing this, then publicly traded stocks generally should not suffer much from unrewarded risk (since this would simply drive their prices down until the stock is "cheap enough" to compensate). Or do you mean to imply that sufficiently small/obscure non-S&P 500 stocks are less efficiently priced? But for what it's worth, Vanguard's S&P 500 and total market funds have comparable performance over their lifetimes.

I could maybe understand the concern that being overly broad might slice into returns due to increased overhead costs, but you'd expect this to manifest as tracking error, and this simply doesn't happen. Vanguard's total market fund, for example, tracks its index within the level of its expense ratio, which is comparable to the S&P 500 fund's expense ratio.
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arcticpineapplecorp.
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Re: 3 Fund - should it be more diversified?

Post by arcticpineapplecorp. »

Why stop at 3 or 4 funds? Have you seen the article at whitecoatinvestor.com entitled, "150 portfolios better than yours"? If not check it out:

http://whitecoatinvestor.com/150-portfo ... han-yours/

Now that you've seen the other 150 possible portfolios, which do you think is best? Why?
It's "Stay" the course, not Stray the Course. Buy and Hold works. You should really try it sometime. Get a plan: www.bogleheads.org/wiki/Investment_policy_statement
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patrick013
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Re: 3 Fund - should it be more diversified?

Post by patrick013 »

xjz wrote:I don't quite understand how "overdiversification" is a problem.
The study I'm referring to is quite old and determined the sweet spot
for a dedicated portfolio is between 500-1000 stocks for diversification.
The market doesn't have alot to do with the main idea. Say you stuff
500 stocks with similar EPS estimates into an index. You have a choice for
501 or more stocks for the index but the stocks to be added have a
debt/equity ratio of 70%. The 500 stocks already in the index have debt/
equity ratios of 40% or less. The new stocks would water the index down,
not be able to sustain growth as well, dividends would likely be less, and
just have lower total return due to larger debt service requirements. But,
the index providers certainly have accounted for that and other factors and
many indexes include thousands of stocks across large/mid/small cap stocks
available for selection. :)
age in bonds, buy-and-hold, 10 year business cycle
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The Three-Fund Portfolio

Post by Taylor Larimore »

boglephreak wrote: Taylor is going to come in here and tell you some combination of the enemy of a good portfolio is a perfect portfolio, and diversification for the sake of diversification is the devil. I tend to agree with him. a three fund portfolio with a possibility of a SCV tilt in the future is all i need.
Boglephreak:

Thank you for saving me a longer post. Many experts agree that three funds is enough:
American Association of Individual Investors: "It should come as no surprise that behavioral finance research makes a strong case for buying and holding low-cost, broadly diversified index funds."

Mark Balasa, CPA, CFP: "That three-pronged approach is going to beat the vast majority of the individual stock and bond portfolio that most people have at brokerage firms. There is a certain elegance in the simplicity of it."

Christine Benz, Morningstar Director of Personal Finance: "It's hard to find fault with the "three-fund portfolio" espoused by many Bogleheads."

Bill Bernstein, author of The Four Pillars of Investing: "Does this (three fund) portfolio seem overly simplistic, even amateurish? Get over it. Over the next few decades, the overwhelming majority of all professional investors will not be able to beat it."

Jack Bogle, "The beauty of owning the market is that you eliminate individual stock risk, you eliminate market sector risk, and you eliminate manager risk. -- There may be better investment strategies than owning just three broad-based index funds but the number of strategies that are worse is infinite."

Warren Buffett, famed investor: “I’d rather be certain of a good return than hopeful of a great one. -- Most investors are better off putting their money in low-cost index funds."

Scott Burns, financial columnist: "The odd are really, really poor than any of us will do better than a low-cost broad index fund."

Jonathan Burton, MarketWatch: "There are plenty of ways to complicate investing, and plenty of people who stand to make money from you as a result. So just think of a three-fund strategy as something you won't have to think about too much."

Andrew Clarke, co-author of Wealth of Experience: "If your stock portfolio looks very different from the broad stock market, you're assuming additional risk that may, or may not, pay off."

Jonathan Clements, author and Wall Street Journal columnist: "Using broad-based index funds to match the market is, I believe, brilliant in its simplicity.

John Cochrane, President American Finance Association: "The market in aggregate always gets the allocation of capital right."

Consumer Reports Money Book: "Simply buy the market as a whole."

Laura Dugu, co-author of The Bogleheads' Guide to Retirement Planning: "With only these three funds in your investment portfolio you can benefit from low costs and broad diversification and still have a portfolio that is easy to manage."

Charles Ellis, author of Winning the Loser's Game: "The stock market is clearly too efficient for most of us to do better."

Nobel Laureate, Eugene Fama: "Whether you decide to tilt toward value depends on whether you are willing to bear the associated risk...The market portfolio is always efficient...For most people, the market portfolio is the most sensible decision."

Paul Farrell, author of The Lazy Person's Guide to Investing: "Where does Fama invest his retirement money? 'In index funds. Mostly the Wilshire 5000.' "

Rick Ferri, Forbes columnist and author of six investment books: "The older I get, the more I believe the 3-fund portfolio is an excellent choice for most people. It's simple, cheap, easy to maintain, and has no tracking error that would cause emotional abandonment to the strategy."

Graham/Zweig, authors of The Intelligent Investor: "The single best choice for a lifelong holding is a total stock-market index fund."

Alan Greenspan, former Chairman of the Federal Reserve: "Prices in the marketplace are by definition the right price."

Mark Hebner, author of Index Funds: “A diversified portfolio which captures the right blend of market indexes reaps the benefit of carrying the systematic risk of the entire market while minimizing exposure to the unsystematic and concentrated risk associated with individual stocks and bonds, countries, industries, or sectors.”

Hulbert Financial Digest: "Buying and holding a broad-market index fund remains the best course of action for most investors."

Sheldon Jacobs, author of No-Load Fund Investing: "The best index fund for almost everyone is the Total Stock Market Index Fund.--The fund can only go wrong if the market goes down and never comes back again, which is not going to happen."

Kiplinger's Retirement Report: "You'll beat most investors with just three funds that cover the vast majority of global stock and bond markets: Vanguard Total Stock Market; Vanguard Total International Stock Index and Vanguard Total Bond Market Index."

Lawrence Kudlow, CNBC: "I like the concept of the Wilshire 5000, which essentially gives you a piece of the rock of all actively traded companies."

Prof. Burton Malkiel, author of Random Walk Down Wall Street: "I recommend a total-maket index fund--one that follows the entire U.S. stock market. And I recommend the same approach for the U.S. bond market and international stocks."

Harry Markowitz, Nobel Laureate: "A foolish attempt to beat the market and get rich quickly will make one's broker rich and oneself much less so."

Bill Miller, famed fund manager: "With the market beating 91% of surviving managers since the beginning of 1982, it looks pretty efficient to me."

Money 101: "If you don’t want to leave your stock and bond allocations up to someone else, you can build a low cost portfolio that own most of the global market with just three funds. A “total stock market” index fund will hold over 3000 stocks, ranging from small companies to established corporate giants. Round that out with an international index fund to cover foreign holdings, and bond index fund."

E.F.Moody, author of No Nonsense Finance: "I am increasingly convinced that the best investment advice for both individual and institutional equity investors is to buy a low-cost broad-based index fund that holds all the stocks comprising the market portfolio."

Motley Fools: "Invest your long-term moolah in index mutual funds that are designed to track the performance of a broad market index."

John Norstad, academic: "For total-market investors, the three disciplines of history, arithmetic, and reason all say that they will succeed in the end."

Suzy Orman: "One of my favorite index funds, Vanguard Total Stock Market (VTSAX), has a total expense ratio of 0.06%"

Anna Pryor Wall Street Journal writer: "A simple portfolio of 3 funds. It may sound counter-intuitive, but for the average individual investor, less is actually more."

Jane Bryant Quinn, syndicated columnist and author of Making the Most of Your Money: "The dependable great investment returns come from index funds which invest in the stock market as a whole."

Pat Regnier, former Morningstar Analyst: "We should just forget about choosing fund managers and settle for index funds to mimic the market."

Ron Ross, author of The Unbeatable Market: "Giving up the futile pursuit of beating the market is the surest way to increase your investment efficiency and enhance your financial peace of mind."

Allan Roth, CPA, CFP, adviser and author of "How a Second Grader Beat Wall Street": "The beauty of a 3-fund portfolio is that it automatically builds the global portfolio without having to worry about standard deviations, correlations, Sharpe ratios, and the like."

Paul Samuelson, Nobel Laureate: "The most efficient way to diversify a stock portfolio is with a low-fee index fund. Statistically, a broadly based stock index fund will outperform most actively managed equity portfolios."

Gus Sauter, former Vanguard Chief Investment Officer: "I think a very good way to gain exposure to the stock market is through the Total Stock Market Portfolio on the domestic side."

Bill Schultheis, author of The Coffee House Investor: "You don't need to have eight funds. You can do it with two or three and have a great portfolio."

Charles Schwab: "Only about one out of every four equity funds outperforms the stock market. That's why I'm a firm believer in the power of indexing."

Chandan Sengupta, author of The Only Proven Road to Investment Success: "Use a low-cost, broad-based index fund to passively invest in a little bit of a large number of stocks."

Prof. Jeremy Siegel, author of Stocks For The Long Run: "For most of us, trying to beat the market leads to disastrous results."

Dan Solin, author of The Smartest Portfolio You'll Ever Own: "You can get as simple or as complicated as you'd like. You can keep it very simple by owning just three mutual funds that invests in domestic stocks, foreign stocks, and bonds. That's precisely what I recommend in my model portfolios."

William Spitz, author of Get Rich Slowly: "Few are able to beat a simple strategy of buying and holding the securities that comprise the market."

Prof. Meir Statman, author of What Investors Really Want: "It makes sense to have those three funds. What makes it hard is that it seems too simple to actually be a winner."

Stein & DeMuth, authors of The Affluent Investor: "Buying and holding a few broad market index funds is perhaps the most important move ordinary investors can make to supercharge their portfolios."

"Robert Stovall, investment manager: It's just not true that you can't beat the market. Every year about one-third do it. Of course, each year it is a different group."

Larry Swedroe, author of 17 financial books: "Over the last 75-years, investors who simply invested passively in the total U.S. stock Market would have doubled their investment approximately every seven years."

Peter D. Teresa, Morningstar Sr. Analyst: My recommendation: "A fund that indexes the entire market, such as Vanguard Total Stock Market Index."

Kent Thune, CFP, editor of The Financial Philosopher: "In keeping with the virtues of passive investing, combined with Bogle’s haystack philosophy, we can capture the entire market of securities with Vanguard index funds, investing in just three broad categories: U.S. stocks, foreign stocks and bonds."

Walter Updegrave, author and senior editor of Money magazine: "Simply invest in the following three funds (or their ETF equivalents): a total U.S. stock market fund, a total international stock market fund and a total U.S bond market fund. Do that, and you'll gain exposure to virtually every type of publicly traded stock in the world (large and small, growth and value, domestic and foreign, all industries and sectors), as well as the entire U.S. investment-grade taxable bond market (short- to long-term maturities, corporates, Treasuries and mortgage-backed issues)."

Wilshire Research: "The market portfolio offers the best ratio of return to risk."

John Woerth, Vanguard Director of Public Relations: "We would agree that this three-fund approach offers most investors a prudent, well-balanced, diversified portfolio at a low cost."

Jason Zweig, Wall Street Journal columnist and author of Your Money and Your Brain: "I think a total stock market index fund is not only the simplest, but the very best core investment for most people."
The Three-Fund Portfolio

Best wishes
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle
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Re: 3 Fund - should it be more diversified?

Post by qwertyjazz »

It is about sufficient not complete. With the ongoing small business ownership, private land and increasing private equity, you cannot own the world. 3 funds is inexpensive, relatively thorough and works.
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Re: 3 Fund - should it be more diversified?

Post by abuss368 »

The Three Fund Portfolio includes thousands of worldwide securities. The investment portfolio is very lost cost and diversified. There is no manager or style risks. Additional funds will probably add complexity.
John C. Bogle: “Simplicity is the master key to financial success."
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Re: 3 Fund - should it be more diversified?

Post by Dandy »

3 fund portfolio is pretty good and simple. If you can handle less simplicity you have to consider what isn't included. e.g. TIPS, muni bonds, other fixed income like CDs, I bonds, EE bonds etc. Also, some people like to tilt e.g. add REITS, small cap value, ]

A caution is that having too many funds/products does make tracking, balancing etc. more of a pain and may not add that much extra performance.

For me I would consider TIPS and CDs or other FDIC products, municipal bonds - I think the total stock and total international stock cover the equity world quite well.
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Re: 3 Fund - should it be more diversified?

Post by am »

Some would argue that a 3 funder is not diversified across factors and therefore is not diversified enough.
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Re: 3 Fund - should it be more diversified?

Post by tludwig23 »

am wrote:Some would argue that a 3 funder is not diversified across factors and therefore is not diversified enough.
Please explain what "diversifying across factors" means.
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in_reality
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Re: 3 Fund - should it be more diversified?

Post by in_reality »

am wrote:Some would argue that a 3 funder is not diversified across factors and therefore is not diversified enough.
People may say that, but it doesn't strike me as accurate. Obviously tilting is concentrating your portfolio.

A three fund portfolio contains all factors in market proportions so along with value stocks you will also hold offsetting growth ones. So basically you will be indifferent if value, for instance, either way out or underperforms.

By tilting to a factor such as value, for instance, you can increase your exposure beyond market weight and take the risk that there will be a premium during your investing horizon. You also induce there risk that you underperform by there not being a premium during that time.

To say a three fund portfolio is not diversified because it is not more highly concentrated in stocks which are believed will offer an additional premium over beta is misleading I think.

You simply must concentrate your holdings in order to get factor exposure.

(note: I do tilt but would never call it additional diversification)
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Re: 3 Fund - should it be more diversified?

Post by Nick341981 »

A better question is, is it too diverse? Warren Buffett and Jack Bogle both seem to think so. Both preach more or less that an S&P 500 index fund offers all the diversity and international exposure that you need. Warren is really big on saying that betting against the USA is dumb. S&P500 plus a index bond fund might be all the diversity you need. Compare for yourself

http://www.marketwatch.com/lazyportfolio
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Re: 3 Fund - should it be more diversified?

Post by tludwig23 »

in_reality wrote:
am wrote:Some would argue that a 3 funder is not diversified across factors and therefore is not diversified enough.
People may say that, but it doesn't strike me as accurate. Obviously tilting is concentrating your portfolio.

A three fund portfolio contains all factors in market proportions so along with value stocks you will also hold offsetting growth ones. So basically you will be indifferent if value, for instance, either way out or underperforms.

By tilting to a factor such as value, for instance, you can increase your exposure beyond market weight and take the risk that there will be a premium during your investing horizon. You also induce there risk that you underperform by there not being a premium during that time.

To say a three fund portfolio is not diversified because it is not more highly concentrated in stocks which are believed will offer an additional premium over beta is misleading I think.

You simply must concentrate your holdings in order to get factor exposure.

(note: I do tilt but would never call it additional diversification)
Exactly. Well stated.
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Re: 3 Fund - should it be more diversified?

Post by PandaBear »

new2bogle2 wrote:
PandaBear wrote:You want a more diversified portfolio than 3 fund? I think the only thing missing is international bond. You could add that.
Things like Commodities wouldn't count as further divqersifying? Would that count as tilting? Are REITs tilting? And this isn't rhetorical, I'm genuinely curious.
Thanks
Are you talking about commodities like gold, silver, and other precious metals? Or commodities like oil, steel, onions, maple syrup, etc? Either way I don't see any reason to do it. You are already invested in the companies that produce these things (BHP Biliton, Exxon, AK Steel, Monsanto). Generally, their performance is tied to how the commodities are doing. The only thing I could think of that I would do is purchase actual, physical gold. But then there's the issue of where to stash it such that you can get to it easily, but is safe enough that it won't be misplaced. Because of these issues, I don't buy gold for investment purposes, I only buy it in jewelry form for the wife.
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Re: 3 Fund - should it be more diversified?

Post by raven15 »

Here's a fun game to play. Go to the Portfolio Charts financial independence calculator https://portfoliocharts.com/portfolio/f ... ependence/ and type in a three fund portfolio with 72% stocks and 28% bonds. Now open the same calculator in a new tab and type "4" into every slot except money market, creating a stupid portfolio with 72% in stocks and 28% in bonds and commodities. Guess which has the higher historical withdrawal rate :mrgreen: .

Just for a little more fun try it again with the portfolio growth calculator https://portfoliocharts.com/portfolio/portfolio-growth/ or the other calculators.
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abuss368
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Re: 3 Fund - should it be more diversified?

Post by abuss368 »

Nick341981 wrote:A better question is, is it too diverse? Warren Buffett and Jack Bogle both seem to think so. Both preach more or less that an S&P 500 index fund offers all the diversity and international exposure that you need. Warren is really big on saying that betting against the USA is dumb. S&P500 plus a index bond fund might be all the diversity you need. Compare for yourself

http://www.marketwatch.com/lazyportfolio
True. Warren Buffett does say to invest in the U.S. However he then invests Berkshire's capital in Israel and China. Berkshire has also issued bonds in Europe. He does puzzle me sometimes.
John C. Bogle: “Simplicity is the master key to financial success."
Dulocracy
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Re: 3 Fund - should it be more diversified?

Post by Dulocracy »

You could be more diverse, but the question is whether or not that diversity meets your goals.

Adding international bonds would be more diversification, however it adds to your bond risk profile without much in the way of additional return. Because of instability in the world, and my confidence in the typical diversified US bond portfolio, I believe that the additional risk in the portion of my portfolio designed to minimize risk is a bad thing. Therefore, I do not add foreign bonds.

Adding commodities would be diverse, but I do not invest in things that are speculative. (Think of a block of gold. Does it produce anything? No... it has value, but it does not produce anything. A bond produces interest on the loan. A business produces product or services to create profit. A commodity, like that brick of gold, is something that was produced. Buying commodities is basically betting that things the fund holds will increase in value. I have a bunch of oranges that were produced. I bought them before they were ever grown. Will I do well or not? Who knows. The weather and other factors have an impact on this product's value. I do not own the gold mine or the orange orchard. I own the thing produced. To me, that is more speculation than money making, so I do not want it in my portfolio. (PLEASE NOTE: This is a gross oversimplification, but it gives you the basic idea.)

What about REITs? A total market fund has REITs at the market weight for publicly traded REITs. However, publicly traded REITS make up much less of a percentage of the real estate owned for profit than a stock fund owns a percentage of the business market. Arguably, REITs are underrepresented in a stock fund. For that reason, I DO have a small REIT add on.

(Full disclosure: I slice and dice, and I tilt small/value. However, if I went with the 3-fund, I would actually go with the 4 fund, adding REITs. Apparently, adding a small allocation of REITs reduces your long term volatility (despite it being as volatile as stocks). This is because sometimes REITs and stock funds zig and zag at different times. (Although sometimes they go up and down at the same time). If you add REITs, whether you add it as a part of your equities or as a 3rd asset class (people debate both of these), it is commonly agreed by both sides that the REIT allotment should come out of the equities side and not the fixed income side, whether you treat it as its own separate asset class or a percentage of overall equities. (The reason to treat it as a separate asset class has to do with trying to skim extra profit at times of rebalancing because you have a 3rd major category against which to rebalance (and it also differs from equities in its structure). The reason for treating it as another equities category is that it technically is an equity (despite different profit models) and that treating it all as the same pie will keep the REIT portion of your portfolio in the proper percentage to the other equities (as opposed to that section growing over time compared to other equities if you have a fixed REIT allocation, yet you are slowly moving equities over to fixed income). Before investing in this asset class, decide which method you want to use and stick with it.)

What about tilting to small and/or value? That is not becoming more diversified. It is less diversified. Also, one should NOT do this at all unless one 1) fully understands the strategy and 2) is willing to commit for the long run. If one is unsure, this is the wrong strategy, as it will have long periods of underperformance, and too many people realize it is not for them after years of investing... and then lock in lower returns because they could not wait for the long haul. This is a very long term strategy, and IT MAY NOT WORK IN TIME FOR YOUR RETIREMENT.

So, my recommendation would be: If you want more diversity, seek it only in the REIT space. Stick with a 3-fund or 4-fund. (Note: as the total market fund and total international own ALL companies on their respective markets, you are not adding diversity by adding a small value fund or a mid-cap fund. You are altering the allocation away from market weights, making the bet that market weights are not the right percentage. This is, in a way, reducing diversity, as you are selecting certain groups of stocks to represent more of your portfolio than they represent as a percentage of the market.
I'm not a financial professional. Post is info only & not legal advice. No attorney-client relationship exists with reader. Scrutinize my ideas as if you spoke with a guy at a bar. I may be wrong.
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