Do You Believe Diversification Is More Important The Shorter The Time Frame?

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Random Walker
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Do You Believe Diversification Is More Important The Shorter The Time Frame?

Post by Random Walker » Thu Mar 15, 2018 2:22 pm

I believe diversification across sources of return is perhaps more important for short time frames. The market can do anything crazy over a short period, so to me seems very logical that diversification important no matter the time frame. This is why I believe diversification is so important for addressing the sequence of returns risk in retirement. Withdrawn money has zero time to recover from losses.

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nisiprius
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Re: Do You Believe Diversification Is More Important The Shorter The Time Frame?

Post by nisiprius » Thu Mar 15, 2018 3:00 pm

"In a crisis, all correlations go to 1."

I believe that "diversification" is no substitute at all for simply investing in lower-risk assets in the first place. If you read footnotes, you will see that in addition to the familiar "past performance" disclaimer, funds that claim "diversification" as a benefit will usually say "Diversification does not ensure a profit or protect against a loss."

If we look at 2008-2009, of course one of the things we find is that many of the new funds and strategies that are attracting interest were not obtainable as mutual funds at that time. But we can look at some that were.
Source

Image

Asset class, percent decline from 12/31/2007, ticker symbol, name:

Real estate, -63%, VGSIX, Vanguard REIT Index
Small-cap value, -58%, DFA US Small-Cap Value Portfolio
International stocks, -58%, Vanguard Total International Stock Index Fund
US Stocks (all), -52%, VTSMX, Vanguard Total Stock Market Index Fund
Commodities, -50%, PCRIX, PIMCO Commodity RealReturn Strategy Fund

Gold, -15%, GLD, SPDR Gold Shares (dark red line)
Bonds, -2%, VBMFX, Vanguard Total Bond Market Index Fund (yellow line)

I don't know what to say about gold except that I thought I ought to show it, and the results are what they are. I don't invest in gold myself and I don't think it's a good idea, but, yes, it did just fine in 2008-2009.

By far the most effective short-term strategy in 2008-2009 was simply to invest in a bond fund... or in gold, the only "diversifier" that fell less than 50%. Certainly, no "low-correlation" mixture of the others with stocks would have made any material difference. All of the other mutual funds on that chart dropped -50% or more.

People are currently looking at alternatives because they believe if bonds are going down at the same time as stocks, bonds are useless. Well, on the face of it, choosing the funds I chose to use and measuring the decline the way I chose to measure them, you can point out that during 2008-2009 stocks, bonds, and gold all went down. That doesn't mean bond funds were useless, I was very glad to be holding a serious allocation to Total Bond during that time frame and I wasn't the least bit upset that it was -2% down at one point.
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Re: Do You Believe Diversification Is More Important The Shorter The Time Frame?

Post by Angst » Thu Mar 15, 2018 3:38 pm

nisiprius wrote:
Thu Mar 15, 2018 3:00 pm
If we look at 2008-2009, of course one of the things we find is that many of the new funds and strategies that are attracting interest were not obtainable as mutual funds at that time. But we can look at some that were.
Source

Image

Asset class, percent decline from 12/31/2007, ticker symbol, name:

Real estate, -63%, VGSIX, Vanguard REIT Index
Small-cap value, -58%, DFA US Small-Cap Value Portfolio
International stocks, -58%, Vanguard Total International Stock Index Fund
US Stocks (all), -52%, VTSMX, Vanguard Total Stock Market Index Fund
Commodities, -50%, PCRIX, PIMCO Commodity RealReturn Strategy Fund

Gold, -15%, GLD, SPDR Gold Shares (dark red line)
Bonds, -2%, VBMFX, Vanguard Total Bond Market Index Fund (yellow line)

I don't know what to say about gold except that I thought I ought to show it, and the results are what they are. I don't invest in gold myself and I don't think it's a good idea, but, yes, it did just fine in 2008-2009.

[snip...]
Nisi,
I had a little trouble reconciling your numbers with the graph at first. Correct me if I'm wrong, but just looking at the graph, it appears to me that these numbers above must be for the period Dec 31, 2007 to Dec 31, 2008, or simply 2008. Including the next year as well, what I'd call "2008-2009", are quite a bit different. Of course, I think 2008 alone could be a reasonable timeframe to consider for making your point.

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Re: Do You Believe Diversification Is More Important The Shorter The Time Frame?

Post by SimpleGift » Thu Mar 15, 2018 3:51 pm

Random Walker wrote:
Thu Mar 15, 2018 2:22 pm
I believe diversification across sources of return is perhaps more important for short time frames.
To echo nisiprius's point above, the diversification that matters most in shorter time frames is the stock/bond mix. Optimally, a risk averse investor with a shorter-term time horizon shouldn't have a large allocation to equities and risk assets to begin with (chart below) — so it matters less the degree to which those risk assets are diversified across various "sources of return."
For an investor with a long time horizon, the diversification of risk assets would seem more important. Just my perspective.
Last edited by SimpleGift on Thu Mar 15, 2018 3:54 pm, edited 1 time in total.
Cordially, Todd

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Re: Do You Believe Diversification Is More Important The Shorter The Time Frame?

Post by Easy Rhino » Thu Mar 15, 2018 3:52 pm

If the investment is extremely conservative, then over a short time I'd argue diversification is unnecessary.

Over the long term, returns might be too low, though.

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Re: Do You Believe Diversification Is More Important The Shorter The Time Frame?

Post by fennewaldaj » Thu Mar 15, 2018 4:02 pm

It seems like this really depends on exactly what stage of the investment process you are in. I have 20-25 years to retirement so if my whole portfolio fell in tandem 50% over the next 2 years say that would not affect me much except to the extent that I let it (I do realize it hurts the geometric mean of returns). So for me diversification is more important over long time periods because I don't want to be entirely invested in the asset that did the worst over that period. In retirement obviously damping volatility is more important.

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Re: Do You Believe Diversification Is More Important The Shorter The Time Frame?

Post by asset_chaos » Thu Mar 15, 2018 7:09 pm

Doesn't it depend on your goals for the short time? If you want maximum safety, then a treasury bond, maturity matched to your time frame, would accomplish your goal but be totally undiversified. On the other hand, if speculation, having a chance at a really high return over the short time, is the goal, then again undiversified probably maximizes whatever small chance you have of accomplishing that goal.
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Re: Do You Believe Diversification Is More Important The Shorter The Time Frame?

Post by David Jay » Thu Mar 15, 2018 7:24 pm

I am rapidly approaching retirement (tentatively Q-1 2019). I am putting my expenses for the 6 years between retirement and start of SS entirely in Bonds: 2 years in short term and 4 years in intermediate term.
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Re: Do You Believe Diversification Is More Important The Shorter The Time Frame?

Post by nisiprius » Thu Mar 15, 2018 8:00 pm

Angst wrote:
Thu Mar 15, 2018 3:38 pm
Nisi,
I had a little trouble reconciling your numbers with the graph at first. Correct me if I'm wrong, but just looking at the graph, it appears to me that these numbers above must be for the period Dec 31, 2007 to Dec 31, 2008, or simply 2008. Including the next year as well, what I'd call "2008-2009", are quite a bit different. Of course, I think 2008 alone could be a reasonable timeframe to consider for making your point.
I was just using 2008-2009 as a name for the stock market crash. My numbers are decline, or "drawdown" as people seem to be calling it now (I don't know why, nothing is being "drawn" down), from 12/31/2007 to the low for that fund (which occurred at slightly different dates for each fund). My point is that except for bonds and gold, every one of the other funds, and the asset class it embodies, was down 50% or more at one time or another. This is a reasonable thing to look at, scine since the original poster is talking about short time frames.
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Johnnie
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Re: Do You Believe Diversification Is More Important The Shorter The Time Frame?

Post by Johnnie » Thu Mar 15, 2018 9:07 pm

nisiprius wrote:
Thu Mar 15, 2018 8:00 pm
Angst wrote:
Thu Mar 15, 2018 3:38 pm
Nisi,
I had a little trouble reconciling your numbers with the graph at first. Correct me if I'm wrong, but just looking at the graph, it appears to me that these numbers above must be for the period Dec 31, 2007 to Dec 31, 2008, or simply 2008. Including the next year as well, what I'd call "2008-2009", are quite a bit different. Of course, I think 2008 alone could be a reasonable timeframe to consider for making your point.
I was just using 2008-2009 as a name for the stock market crash. My numbers are decline, or "drawdown" as people seem to be calling it now (I don't know why, nothing is being "drawn" down), from 12/31/2007 to the low for that fund (which occurred at slightly different dates for each fund). My point is that except for bonds and gold, every one of the other funds, and the asset class it embodies, was down 50% or more at one time or another. This is a reasonable thing to look at, scine since the original poster is talking about short time frames.
Ever since I first read your report on this in a previous post - events I remember well myself - I've wondered how that across-the-board hammering compared to other big declines. A limitation is that many of the asset classes in the comparison have not been around or investable for long. Some of those asset classes were available in 2000 at least. More generally, how common is it in these periodic bloodbaths that the slaughter is so "ecumenical," taking all kinds of asset classes thought non-correlated down in unison?
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Re: Do You Believe Diversification Is More Important The Shorter The Time Frame?

Post by Rysto » Thu Mar 15, 2018 10:57 pm

I believe that diversification is far more important the longer the time frame. The market is unforgiving, and there are a lot of ways that an investment can go wrong. If we're talking about a stock, for instance, good managers could be replaced with poor ones who run the company into the ground, or the company could pursue a bad strategy, or a new technology could invalidate the company's business model, or the company can take a big risk just before a recession and leave the company over-leveraged, etc, etc. The longer you hold a single stock, the higher your chances that the stock will hit one of these pitfals and crater.

Think of it this way: if you were forced to invest your life's savings in a single stock, would you feel more comfortable doing that for a holding period of 1 year or 50 years? To me, the answer is clearly 1 year. Over the course of 50 years the world will change so much that trying to choose a stock that won't stumble over such a long period is a fool's errand. Over the course of one year the likelihood of a single stock going to zero is quite slim. But probability is a harsh mistress, and over the long term those small chances really start to add up.

This isn't to say that I'd be comfortable with a single stock for 1 year, of course.

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Re: Do You Believe Diversification Is More Important The Shorter The Time Frame?

Post by Top99% » Fri Mar 16, 2018 7:57 am

I am also in the "diversification is more important for longer time frame" camp. Short term CDs or low risk bonds work fine for the short term for me. Longer term I need our portfolio to support a level of spending which may or may not track the growth rate of the CPI since the basket of goods and services DW and I spend on is certainly not well represented by the one used for the CPI. Since I need short term FI/CDs to deal with short term risk I need the rest of the portfolio to grow at a rate that will support future spending. I am convinced diversification can help with allowing me to keep enough short term CDs/FI to cover short term (10 year) risk while providing enough growth cover long term risk.
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Re: Do You Believe Diversification Is More Important The Shorter The Time Frame?

Post by Angst » Fri Mar 16, 2018 7:57 am

nisiprius wrote:
Thu Mar 15, 2018 8:00 pm
Angst wrote:
Thu Mar 15, 2018 3:38 pm
Nisi,
I had a little trouble reconciling your numbers with the graph at first. Correct me if I'm wrong, but just looking at the graph, it appears to me that these numbers above must be for the period Dec 31, 2007 to Dec 31, 2008, or simply 2008. Including the next year as well, what I'd call "2008-2009", are quite a bit different. Of course, I think 2008 alone could be a reasonable timeframe to consider for making your point.
I was just using 2008-2009 as a name for the stock market crash. My numbers are decline, or "drawdown" as people seem to be calling it now (I don't know why, nothing is being "drawn" down), from 12/31/2007 to the low for that fund (which occurred at slightly different dates for each fund). My point is that except for bonds and gold, every one of the other funds, and the asset class it embodies, was down 50% or more at one time or another. This is a reasonable thing to look at, scine since the original poster is talking about short time frames.
Thank you, I understand now and continue to agree with what you were pointing out.

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Re: Do You Believe Diversification Is More Important The Shorter The Time Frame?

Post by SGM » Fri Mar 16, 2018 9:01 am

Diversification among stocks by purchasing index funds is a good thing. I am not convinced that diversifying by owning more bonds is a good thing for those earlier in the accumulation phase if you have job security, disability insurance and the stomach for a bear market.

As a retiree I am quite diversified. If you may need to cash out of stocks in a downturn then you do not own enough bonds. Some cannot tolerate downturns and sell in a panic. If you feel you would be subjecting to selling out of fear or whatever reason then you do not own enough bonds.

I have further diversified by delaying SS until 70 and will likely purchase SPIA ladders although I am not generally considered to be one who would need to purchase an SPIA. I have determined that by delaying SS and purchasing some SPIAs that i will leave a larger legacy and spend more money. Likely I will be happier by seeing more money come into my checking account regularly as it did while working :D

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