Diversification Regret

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vineviz
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Diversification Regret

Post by vineviz » Fri Nov 02, 2018 11:20 am

Many investors have a hard time keeping their portfolios fully and properly diversified, and I suspect that regret-aversion plays some role in this.

In other words, it can be difficult to holding an asset class that has recently underperformed a prominent market barometer (e.g. the S&P 500) because it is very easy to visualize how much more money the investor might have if they'd just invested solely in the better performing asset.

I call this "diversification regret".

This diversification regret can persist and grow, it seems to me, because the benefits of diversification can sometimes appear suddenly and intensely at times but be indiscernible at other times.

I wondered if there was a way to visualize "diversification regret", and I settled on constructing an index based on comparing the returns of the S&P 500 to the returns of a diversified portfolio (large cap US stocks, small cap value US stocks, international stocks, & long-term bonds). The actual composition of this diversified portfolio is somewhat arbitrary, but I think it represents well enough what I'm hoping to achieve.

For each month since 1993, I subtracted the returns of the diversified portfolio from the returns of the S&P 500 assuming an initial $100 investment (so the index value starts at 100) then plotted the cumulative return.

Image

When the index is above 100, the diversified portfolio has cumulatively underperformed the the S&P 500.

Working from left to right, the chart illustrates the difficulty many investors might have had in holding a diversified portfolio from 1994 to 1999. The dot-com bubble was going strong, and the large cap growth stocks in the the S&P 500 were on a roll. The diversified assets (SCV, international, bonds) generally had good returns, but nowhere near the 20% annualized returns of the large cap stocks.

From 1999 to 2009, though, it's a different story. This is the infamous "lost decade" for the S&P 500 with negative compound annual growth of -3.52%. The diversified assets (SCV, international, bonds) had returns that were not stellar on an absolute basis but were vastly superior to the US large cap stocks during that decade as represented by the long downward slope in the diversification regret index.

From 2009 until today, we largely see a repeat of what happened in the 1990s: good performance by all assets on an absolute basis, but somewhat dwarfed by outside gains in US large cap stocks.

I'm not predicting that the next 10 years will look like 1999 to 2009, but I do think it is worth remembering that in the past when the benefits of diversification appeared to have disappeared they soon came back with a vengeance.

Here's link to the portfolio I used to construct the index:

-24% Vanguard Total Stock Mkt Idx Inv (VTSMX)
-24% DFA US Small Cap Value I (DFSVX)
-32% DFA Large Cap International I (DFALX)
-20% Vanguard Long-Term Treasury Inv (VUSTX)
100% Vanguard 500 Index Investor (VFINX)

https://www.portfoliovisualizer.com/bac ... ion5_1=100

I used the DFA funds primarily for their early inception dates and semi-passive management style.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Diversification Regret

Post by nedsaid » Fri Nov 02, 2018 11:27 am

I am glad someone weighed in on this, reminding Bogleheads that diversification is still important. I have been joking about the "one fund portfolio" or the S&P 500. International isn't doing well in 2018 and neither are bonds. The stock market is up and down, up again and down again, and so forth in 2018 and even the S&P 500 isn't doing so great. Perhaps we will be down to the Zero Fund portfolio at the rate we are going. I still say it makes sense to diversify not only across asset classes but across factors as well.
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Re: Diversification Regret

Post by HEDGEFUNDIE » Fri Nov 02, 2018 11:33 am

I like the approach vineviz.

In practice, there would be a few “capitulation points” where the 100% S&P 500 investor threw in the towel and sold everything due to severe drawdown, capitulations which would not occur as often with a diversified portfolio.

This behavioral-informed comparison would have cumulative returns looking better for the diversified portfolio.

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Re: Diversification Regret

Post by ReformedSpender » Fri Nov 02, 2018 11:34 am

Great post, thank you

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Re: Diversification Regret

Post by nisiprius » Fri Nov 02, 2018 11:43 am

I like the idea and the chart (except for the unnecessary decoration represented by the vertical "brush strokes.")
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Re: Diversification Regret

Post by aristotelian » Fri Nov 02, 2018 11:55 am

You say "when the index is above 100, the diversified portfolio has underperformed". So the 150 in 1999 means that the diversified portfolio had underperformed by 50% cumulatively to that point?

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Re: Diversification Regret

Post by siamond » Fri Nov 02, 2018 11:57 am

OP, what you did is essentially a Telltale chart. And yes, such charts are very useful to understand the comparative dynamics of two strategies over time.

PS. Oh, and I like the brush strokes! :wink:

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Re: Diversification Regret

Post by jwblue » Fri Nov 02, 2018 11:59 am

I am a novice investor so some of this is esoteric for me.

What is the takeaway from this in one sentence that a novice investor can understand?

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Re: Diversification Regret

Post by bloom2708 » Fri Nov 02, 2018 11:59 am

Not following.

You are comparing the S&P 500 to a "diversified" portfolio with large cap, long bonds, only emerging international and small cap value?

Brings us full circle on the definition of diversified. :|

How about comparing Total World + 20% Int-Term Bonds to a tilted portfolio of Large cap, small cap value, emerging international + long-term bonds?

At least have them both have 20% of some bonds or 0%.
"We are not here to please, but to provoke thoughtfulness." --Unknown Boglehead

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vineviz
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Re: Diversification Regret

Post by vineviz » Fri Nov 02, 2018 12:07 pm

aristotelian wrote:
Fri Nov 02, 2018 11:55 am
You say "when the index is above 100, the diversified portfolio has underperformed". So the 150 in 1999 means that the diversified portfolio had underperformed by 50% cumulatively to that point?
That's basically right: by October 1993 the undiversified portfolio was worth about 54% more than the diversified portfolio.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Diversification Regret

Post by HEDGEFUNDIE » Fri Nov 02, 2018 12:07 pm

bloom2708 wrote:
Fri Nov 02, 2018 11:59 am
Not following.

You are comparing the S&P 500 to a "diversified" portfolio with large cap, long bonds, only emerging international and small cap value?

Brings us full circle on the definition of diversified. :|

How about comparing Total World + 20% Int-Term Bonds to a tilted portfolio of Large cap, small cap value, emerging international + long-term bonds?

At least have them both have 20% of some bonds or 0%.
I’m pretty sure vineviz did not intend for this thread to devolve into an argument about the definition of a diversified portfolio. I’ll just make the point that many of us believe that diversification means a collection of mutually uncorrelated assets. And so Long Bonds are included instead of Int Bonds because the former are less correlated to the S&P 500 than the latter. Again, feel free to disagree, but let’s not sidetrack the point of this thread. I don’t believe the chart would change meaningfully if he had used VT + BND.

As far as why he did not include bonds in the “non-diversified” portfolio, I think it’s a valid choice because a person not wedded to diversification would be prone to sell his underperforming bonds at the first opportunity.
Last edited by HEDGEFUNDIE on Fri Nov 02, 2018 12:21 pm, edited 2 times in total.

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Re: Diversification Regret

Post by JoMoney » Fri Nov 02, 2018 12:09 pm

"Tracking error" regret is a real risk (Larry Swedroe 2012)
... Unfortunately, my experiences as both an investor and advisor have taught me that diversification isn't truly a free lunch for most investors -- with it comes the very real risk known as "tracking error regret."

Tracking error is defined as the difference between a fund or portfolio and a benchmark. Most often the benchmark is a commonly referred to index such as the S&P 500 Index. If your portfolio consists solely of an investment in an S&P 500 fund, you're not exposed to any tracking error risk. ...
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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vineviz
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Re: Diversification Regret

Post by vineviz » Fri Nov 02, 2018 12:11 pm

jwblue wrote:
Fri Nov 02, 2018 11:59 am
I am a novice investor so some of this is esoteric for me.

What is the takeaway from this in one sentence that a novice investor can understand?
Wow, I'm not sure I can do that question justice but here's an attempt in two sentences: It can be psychologically difficult to hold a diversified portfolio, especially when past performance of that diversified portfolio has been uninspiring. It's important to remember that the benefits of diversification have appeared to be absent in the past (as they currently appear to some investors now), but we can use history as our guide in being confident that the benefits of diversification will show up and reward us.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

staythecourse
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Re: Diversification Regret

Post by staythecourse » Fri Nov 02, 2018 12:17 pm

Excellent post. Your "diversification regret" is basically the "frame of reference risk" folks talk about. I have NO CLUE why folks follow popular benchmarks like the sp500. I never did when I started investing and I still don't. It makes it seem to the investor they are doing something wrong when their returns are not the same as the sp500 when it shouldn't. Most folks are not 100% stocks. Those that are usually not in 100% U.S. only. Of those that are they are usually not in 100% large cap blend (sp500). So the question that really matters is WHY do folks even pay attention to the sp500?

What would be useful is folks having their own proper benchmark and looking at their return to that when they are evaluating their performances.

As Mr. Gibson says in his book, "Asset Allocation" (paraphrasing), "Being diversified means always being unhappy. You will always hold too many of the losers and not enough of the winners".

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

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Re: Diversification Regret

Post by staythecourse » Fri Nov 02, 2018 12:20 pm

jwblue wrote:
Fri Nov 02, 2018 11:59 am
I am a novice investor so some of this is esoteric for me.

What is the takeaway from this in one sentence that a novice investor can understand?
No problem. This means do not use Sp500 as your benchmark unless you are 100% large cap U.S. stocks. Anything other then that means you are using an inappropriate benchmark.

Pick a suitable benchmark to your asset allocation and don't be upset when it doesn't follow the sp500 (as it shouldn't). Don't look at your portfolio as a failure if it doesn't follow the same returns as the sp500.

Hope that helps.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

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Re: Diversification Regret

Post by Jack FFR1846 » Fri Nov 02, 2018 12:20 pm

Next time we get a thread titled "Why have bonds at all?" during a bull run, link this thread.
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Re: Diversification Regret

Post by HEDGEFUNDIE » Fri Nov 02, 2018 12:24 pm

staythecourse wrote:
Fri Nov 02, 2018 12:17 pm
Excellent post. Your "diversification regret" is basically the "frame of reference risk" folks talk about. I have NO CLUE why folks follow popular benchmarks like the sp500. I never did when I started investing and I still don't. It makes it seem to the investor they are doing something wrong when their returns are not the same as the sp500 when it shouldn't. Most folks are not 100% stocks. Those that are usually not in 100% U.S. only. Of those that are they are usually not in 100% large cap blend (sp500). So the question that really matters is WHY do folks even pay attention to the sp500?
This is a great point. If you use the S&P 600 as your reference point your regret index would be even higher.

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vineviz
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Re: Diversification Regret

Post by vineviz » Fri Nov 02, 2018 12:40 pm

JoMoney wrote:
Fri Nov 02, 2018 12:09 pm
"Tracking error" regret is a real risk (Larry Swedroe 2012)
... Unfortunately, my experiences as both an investor and advisor have taught me that diversification isn't truly a free lunch for most investors -- with it comes the very real risk known as "tracking error regret."

Tracking error is defined as the difference between a fund or portfolio and a benchmark. Most often the benchmark is a commonly referred to index such as the S&P 500 Index. If your portfolio consists solely of an investment in an S&P 500 fund, you're not exposed to any tracking error risk. ...
Yes, and I think another implication is that in addition to thinking about "risk tolerance" (which informs the overall asset allocation) we might serve many investors better if we measure "regret tolerance" in a similar fashion.

I don't have any evidence on this, but I suspect that typically the most regret-averse investors have tended to either utilize a financial advisor (thereby delegating the decisions to a professional and proactively avoiding generating regret about their own investment choices), have invested in a manner that resembles performance chasing (i.e. continually regretting their past decisions and moving to assets that outperformed the ones they chose), or else have sat out of capital markets altogether (a behavior that resembles extreme risk-aversion but has a different psychological motivation).

My view is that regret-averse investors are possibly much better served by being encouraged to use a single balanced fund (like target date funds or Vanguard's LifeStrategy funds) rather than an unbundled collection of individual funds. Balanced fund investors are not necessarily immune from feeling regret, but they are structurally preventing themselves from acting on it to a large degree.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Diversification Regret

Post by asif408 » Fri Nov 02, 2018 12:42 pm

Interesting way to look at things, thanks for sharing. One thing that is noteworthy is though the magnitude of the underperformance is less than it was from 1994-1999, the duration has been longer (2010-2018). So I imagine it's even more difficult for investors when things have been going one way for so long with no turn in sight.

Just for kicks, I plugged in something similar to what you did and used 3 of the worst performing segments of the markets in the last 7 years: emerging markets, precious metals equities, and energy stocks. The "diversification regret" has been even higher in those markets: https://www.portfoliovisualizer.com/bac ... ion8_2=-33
Last edited by asif408 on Fri Nov 02, 2018 12:56 pm, edited 2 times in total.

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Re: Diversification Regret

Post by bloom2708 » Fri Nov 02, 2018 12:43 pm

HEDGEFUNDIE wrote:
Fri Nov 02, 2018 12:07 pm
bloom2708 wrote:
Fri Nov 02, 2018 11:59 am
Not following.

You are comparing the S&P 500 to a "diversified" portfolio with large cap, long bonds, only emerging international and small cap value?

Brings us full circle on the definition of diversified. :|

How about comparing Total World + 20% Int-Term Bonds to a tilted portfolio of Large cap, small cap value, emerging international + long-term bonds?

At least have them both have 20% of some bonds or 0%.
I’m pretty sure vineviz did not intend for this thread to devolve into an argument about the definition of a diversified portfolio. I’ll just make the point that many of us believe that diversification means a collection of mutually uncorrelated assets. And so Long Bonds are included instead of Int Bonds because the former are less correlated to the S&P 500 than the latter. Again, feel free to disagree, but let’s not sidetrack the point of this thread. I don’t believe the chart would change meaningfully if he had used VT + BND.

As far as why he did not include bonds in the “non-diversified” portfolio, I think it’s a valid choice because a person not wedded to diversification would be prone to sell his underperforming bonds at the first opportunity.
I understand. Why not use Amazon stock performance instead of the S&P 500? S&P 500 at least diversifies across ~500 good companies.

My results with US, International and US bonds seems pretty paltry compared to Amazon. Yet, I avoid the regret.
"We are not here to please, but to provoke thoughtfulness." --Unknown Boglehead

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Re: Diversification Regret

Post by HEDGEFUNDIE » Fri Nov 02, 2018 12:50 pm

bloom2708 wrote:
Fri Nov 02, 2018 12:43 pm
HEDGEFUNDIE wrote:
Fri Nov 02, 2018 12:07 pm
bloom2708 wrote:
Fri Nov 02, 2018 11:59 am
Not following.

You are comparing the S&P 500 to a "diversified" portfolio with large cap, long bonds, only emerging international and small cap value?

Brings us full circle on the definition of diversified. :|

How about comparing Total World + 20% Int-Term Bonds to a tilted portfolio of Large cap, small cap value, emerging international + long-term bonds?

At least have them both have 20% of some bonds or 0%.
I’m pretty sure vineviz did not intend for this thread to devolve into an argument about the definition of a diversified portfolio. I’ll just make the point that many of us believe that diversification means a collection of mutually uncorrelated assets. And so Long Bonds are included instead of Int Bonds because the former are less correlated to the S&P 500 than the latter. Again, feel free to disagree, but let’s not sidetrack the point of this thread. I don’t believe the chart would change meaningfully if he had used VT + BND.

As far as why he did not include bonds in the “non-diversified” portfolio, I think it’s a valid choice because a person not wedded to diversification would be prone to sell his underperforming bonds at the first opportunity.
I understand. Why not use Amazon stock performance instead of the S&P 500? S&P 500 at least diversifies across ~500 good companies.

My results with US, International and US bonds seems pretty paltry compared to Amazon. Yet, I avoid the regret.
The worst case of this is if you work for a company that has had a huge run up in shares and you receive those shares regularly as part of your compensation. And you sell those shares as soon as you get them like a good Boglehead.

:oops:

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Re: Diversification Regret

Post by mervinj7 » Fri Nov 02, 2018 1:07 pm

HEDGEFUNDIE wrote:
Fri Nov 02, 2018 12:50 pm
The worst case of this is if you work for a company that has had a huge run up in shares and you receive those shares regularly as part of your compensation. And you sell those shares as soon as you get them like a good Boglehead.

:oops:
Yep, I know what you mean. I've been selling my company shares as soon as they vest and reinvesting according to my AA. Compared to my coworkers, I've been missing out on a quite a bit of gains.

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Re: Diversification Regret

Post by galeno » Fri Nov 02, 2018 1:20 pm

When you invest in ONE all world all cap equity fund/ETF (e.g. VT) this worry is null and void.

Bogleheads tend to view equities as USA, non-USA developed, and EM. Each one of those categories can be divided by size (large, mid, and small) and type (growth or value).

When you buy and hold "the entire global equity haystack" one thing is certain. You will NEVER win the equity horse race on a year over year basis.
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Re: Diversification Regret

Post by longinvest » Fri Nov 02, 2018 1:36 pm

siamond wrote:
Fri Nov 02, 2018 11:57 am
OP, what you did is essentially a Telltale chart. And yes, such charts are very useful to understand the comparative dynamics of two strategies over time.
It's not exactly a Telltale chart, but it's very similar. This OP's chart shows the arithmetic difference on a weird net 0% allocation investment (due to leverage). The Telltale chart shows the ratio of one investment over the other. In other words: one is additive, the other is multiplicative.

Yet, what I like is the Portfolio Visualizer trick in the OP to get a Telltale-like chart easily. Neat! I thought that Portfolio Visualizer always wanted a 100% allocation. I guess that the OP found an unsuspected hole in Portfolio Visualizer's code. It must have assumed that a total of zero meant that no allocation was provided. So, it's probably a Portfolio Visualizer unanticipated feature.
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Re: Diversification Regret

Post by Abe » Fri Nov 02, 2018 1:41 pm

vineviz wrote:
Fri Nov 02, 2018 12:11 pm
jwblue wrote:
Fri Nov 02, 2018 11:59 am
I am a novice investor so some of this is esoteric for me.

What is the takeaway from this in one sentence that a novice investor can understand?
Wow, I'm not sure I can do that question justice but here's an attempt in two sentences: It can be psychologically difficult to hold a diversified portfolio, especially when past performance of that diversified portfolio has been uninspiring. It's important to remember that the benefits of diversification have appeared to be absent in the past (as they currently appear to some investors now), but we can use history as our guide in being confident that the benefits of diversification will show up and reward us.
Why didn't you just say that to start with. Just joking. :happy
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Re: Diversification Regret

Post by bloom2708 » Fri Nov 02, 2018 1:56 pm

galeno wrote:
Fri Nov 02, 2018 1:20 pm
When you invest in ONE all world all cap equity fund/ETF (e.g. VT) this worry is null and void.

Bogleheads tend to view equities as USA, non-USA developed, and EM. Each one of those categories can be divided by size (large, mid, and small) and type (growth or value).

When you buy and hold "the entire global equity haystack" one thing is certain. You will NEVER win the equity horse race on a year over year basis.
But, but, you also won't lose the equity horse race. Most people under perform "the market". Holding "all" the global stocks at market cap weight ensures you get the market return (less expenses of course).

Maybe you implied this, but your statement seems to imply beating/winning compared to "the market" is the goal.
"We are not here to please, but to provoke thoughtfulness." --Unknown Boglehead

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Re: Diversification Regret

Post by Random Walker » Fri Nov 02, 2018 2:14 pm

For me,the way to avoid “diversification regret” is to appreciate the relationship between past returns, current valuations, and future expected returns. When an asset class has done well, enjoy the past returns. When an asset class has done poorly and valuations are lower, look forward to increased expected returns.

I play a game with myself daily where I compare all my individual fund returns (small, value, Int, bonds, alts) to the S&P500. Setting myself up for all sorts of pain and behavioral errors, but can’t resist nonetheless.

Dave

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Re: Diversification Regret

Post by staythecourse » Fri Nov 02, 2018 7:19 pm

vineviz wrote:
Fri Nov 02, 2018 12:40 pm
My view is that regret-averse investors are possibly much better served by being encouraged to use a single balanced fund (like target date funds or Vanguard's LifeStrategy funds) rather than an unbundled collection of individual funds. Balanced fund investors are not necessarily immune from feeling regret, but they are structurally preventing themselves from acting on it to a large degree.
Not sure if that would help. The guy who is 60/40 balanced index fund would look up in the late 90's and still think they did something wrong when they saw year after year +30% gains.

I think folks should use an appropriate lifestyle fund as their benchmark if they are using a standard 110- age or something like that as their stock/ bond allocation. That would a more reasonable comparison and thus minimize frame of reference risk. Not perfect, but MUCH better then the, "Hey did you hear the sp500 is x this year?"

Personally, I have never calculated by own returns in any year. To get an approximation I go to morningstar at the end of the year at xray the subassets I own in weighted average to see how I did for the year.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

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Re: Diversification Regret

Post by tennisplyr » Sat Nov 03, 2018 6:20 pm

If the diversification portfolio likely consists of cash and bonds, why would you ever expect it to beat the S&P over the long haul....apples and oranges??
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Re: Diversification Regret

Post by columbia » Sat Nov 03, 2018 7:05 pm

Diversification benefits are hypothetical - unless they actually happen.

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Re: Diversification Regret

Post by bgf » Sat Nov 03, 2018 7:15 pm

JoMoney wrote:
Fri Nov 02, 2018 12:09 pm
"Tracking error" regret is a real risk (Larry Swedroe 2012)
... Unfortunately, my experiences as both an investor and advisor have taught me that diversification isn't truly a free lunch for most investors -- with it comes the very real risk known as "tracking error regret."

Tracking error is defined as the difference between a fund or portfolio and a benchmark. Most often the benchmark is a commonly referred to index such as the S&P 500 Index. If your portfolio consists solely of an investment in an S&P 500 fund, you're not exposed to any tracking error risk. ...
if you can't handle the downs, you haven't earned the ups. simple as that. this applies to both absolute returns as well as comparative returns.

we all FEEL regret-aversion, loss-aversion. we are human beings, and none of us is "special" in that regard. the most you can do is retrain yourself with past experience wisdom/knowledge to act differently.
“TE OCCIDERE POSSUNT SED TE EDERE NON POSSUNT NEFAS EST"

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Re: Diversification Regret

Post by randomguy » Sat Nov 03, 2018 7:27 pm

HEDGEFUNDIE wrote:
Fri Nov 02, 2018 11:33 am
I like the approach vineviz.

In practice, there would be a few “capitulation points” where the 100% S&P 500 investor threw in the towel and sold everything due to severe drawdown, capitulations which would not occur as often with a diversified portfolio.

This behavioral-informed comparison would have cumulative returns looking better for the diversified portfolio.
And what about the capitulation points where people give up on every othwr asset? See the why bonds and why international threads.😁 And I am sure in Jan 2000 there were why small value thread.

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Re: Diversification Regret

Post by fortyofforty » Sat Nov 03, 2018 9:02 pm

I regret being "diversified" in international. It's roughly correlated with domestic equities, but just doesn't rise as fast on the way up. It seems to drop just as fast, though. I read learned Bogleheads, led by the namesake himself, declaring that there is no justifiable reason to own international equities. Yet, I continue to pour money into that asset sub class. It might be a mistake and a drag on my portfolio, but I continue on. At what point do you dump an underperformer, and when do you give up on the "experiment" or the "theory" or the "hypothesis", especially when it might be unnecessary overdiversification?
"In a time of universal deceit, telling the truth becomes a revolutionary act." - George Orwell | There are many roads to doublin'. | Original Vanguard Diehard

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Re: Diversification Regret

Post by HEDGEFUNDIE » Sat Nov 03, 2018 9:29 pm

fortyofforty wrote:
Sat Nov 03, 2018 9:02 pm
At what point do you dump an underperformer, and when do you give up on the "experiment" or the "theory" or the "hypothesis", especially when it might be unnecessary overdiversification?
You don’t.

Learn to enjoy the pain.

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Re: Diversification Regret

Post by MJW » Sun Nov 04, 2018 12:44 am

fortyofforty wrote:
Sat Nov 03, 2018 9:02 pm
I regret being "diversified" in international. It's roughly correlated with domestic equities, but just doesn't rise as fast on the way up. It seems to drop just as fast, though. I read learned Bogleheads, led by the namesake himself, declaring that there is no justifiable reason to own international equities. Yet, I continue to pour money into that asset sub class. It might be a mistake and a drag on my portfolio, but I continue on.
I actually hold international equities at an amount I call "the regret level." It's enough for it to matter either way, which means one day I will either regret having held it at all, or I will regret not holding more. :oops:

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Re: Diversification Regret

Post by whodidntante » Sun Nov 04, 2018 1:25 am

Poker players refer to this as "playing results" or "resulting." You can play terribly and still win, or play well and still lose. The benefits of diversification are strongest when the herd thinks you're crazy for not piling into what did well recently.

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Re: Diversification Regret

Post by indexonlyplease » Sun Nov 04, 2018 7:25 am

fortyofforty wrote:
Sat Nov 03, 2018 9:02 pm
I regret being "diversified" in international. It's roughly correlated with domestic equities, but just doesn't rise as fast on the way up. It seems to drop just as fast, though. I read learned Bogleheads, led by the namesake himself, declaring that there is no justifiable reason to own international equities. Yet, I continue to pour money into that asset sub class. It might be a mistake and a drag on my portfolio, but I continue on. At what point do you dump an underperformer, and when do you give up on the "experiment" or the "theory" or the "hypothesis", especially when it might be unnecessary overdiversification?
I want to follow up on this question with another question

Say you own the 3 fund (I do) and you plan to keep it long term.
Your goal is to reballance once a year in January.
You are also retired so you can't add money to the taxed deferred account.
Your AA (50/50) is ok for risk meaning you are happy with the % of fixed income at the end of they year.
You decide not to reballance the stocks (80/20 goal in stocks) just let them ride out the market and see what happens. Meaning you will take what the 2 funds give you. Just let them reballance themselves.

What will be the negative effect??

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Re: Diversification Regret

Post by fortyofforty » Sun Nov 04, 2018 9:17 am

whodidntante wrote:
Sun Nov 04, 2018 1:25 am
Poker players refer to this as "playing results" or "resulting." You can play terribly and still win, or play well and still lose. The benefits of diversification are strongest when the herd thinks you're crazy for not piling into what did well recently.
Perhaps. But at what cost, and for what benefit? Holding international might provide my overall portfolio slightly better results, or slightly worse results. Would it be smarter to follow Jack's advice and just accept what domestic equities give and forgo the risk/reward trap of international? It's not really providing any counter-correlation, just up and down with domestic, for higher costs and poorer performance. Yet, I keep calm and international on.
"In a time of universal deceit, telling the truth becomes a revolutionary act." - George Orwell | There are many roads to doublin'. | Original Vanguard Diehard

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Re: Diversification Regret

Post by HEDGEFUNDIE » Sun Nov 04, 2018 9:36 am

indexonlyplease wrote:
Sun Nov 04, 2018 7:25 am
fortyofforty wrote:
Sat Nov 03, 2018 9:02 pm
I regret being "diversified" in international. It's roughly correlated with domestic equities, but just doesn't rise as fast on the way up. It seems to drop just as fast, though. I read learned Bogleheads, led by the namesake himself, declaring that there is no justifiable reason to own international equities. Yet, I continue to pour money into that asset sub class. It might be a mistake and a drag on my portfolio, but I continue on. At what point do you dump an underperformer, and when do you give up on the "experiment" or the "theory" or the "hypothesis", especially when it might be unnecessary overdiversification?
I want to follow up on this question with another question

Say you own the 3 fund (I do) and you plan to keep it long term.
Your goal is to reballance once a year in January.
You are also retired so you can't add money to the taxed deferred account.
Your AA (50/50) is ok for risk meaning you are happy with the % of fixed income at the end of they year.
You decide not to reballance the stocks (80/20 goal in stocks) just let them ride out the market and see what happens. Meaning you will take what the 2 funds give you. Just let them reballance themselves.

What will be the negative effect??
There are two reasons to rebalance:

1. Moving money between assets that have different levels of risk (e.g. stocks vs bonds) ,so that your overall portfolio does not end up too risky or too conservative.

2. Selling winners and buying losers, to set yourself up for mean reversion to work in your favor.

The first reason is much more important for portfolio health than the second reason. And the first reason does not really apply in the case of rebalancing among stocks (US and Intl stocks are similarly risky). Therefore if I had no new money coming in I would not bother with rebalancing stocks.

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Re: Diversification Regret

Post by abuss368 » Sun Nov 04, 2018 9:45 am

nedsaid wrote:
Fri Nov 02, 2018 11:27 am
Perhaps we will be down to the Zero Fund portfolio at the rate we are going.
Hi nedsaid -

That line catches my attention every time. Well said.
John C. Bogle: "You simply do not need to put your money into 8 different mutual funds!" | | Disclosure: Three Fund Portfolio + U.S. & International REITs

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Re: Diversification Regret

Post by abuss368 » Sun Nov 04, 2018 9:49 am

jwblue wrote:
Fri Nov 02, 2018 11:59 am
What is the takeaway from this in one sentence that a novice investor can understand?
Diversification is the only free lunch in investing.
John C. Bogle: "You simply do not need to put your money into 8 different mutual funds!" | | Disclosure: Three Fund Portfolio + U.S. & International REITs

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Re: Diversification Regret

Post by indexonlyplease » Sun Nov 04, 2018 11:56 am

HEDGEFUNDIE wrote:
Sun Nov 04, 2018 9:36 am
indexonlyplease wrote:
Sun Nov 04, 2018 7:25 am
fortyofforty wrote:
Sat Nov 03, 2018 9:02 pm
I regret being "diversified" in international. It's roughly correlated with domestic equities, but just doesn't rise as fast on the way up. It seems to drop just as fast, though. I read learned Bogleheads, led by the namesake himself, declaring that there is no justifiable reason to own international equities. Yet, I continue to pour money into that asset sub class. It might be a mistake and a drag on my portfolio, but I continue on. At what point do you dump an underperformer, and when do you give up on the "experiment" or the "theory" or the "hypothesis", especially when it might be unnecessary overdiversification?
I want to follow up on this question with another question

Say you own the 3 fund (I do) and you plan to keep it long term.
Your goal is to reballance once a year in January.
You are also retired so you can't add money to the taxed deferred account.
Your AA (50/50) is ok for risk meaning you are happy with the % of fixed income at the end of they year.
You decide not to reballance the stocks (80/20 goal in stocks) just let them ride out the market and see what happens. Meaning you will take what the 2 funds give you. Just let them reballance themselves.

What will be the negative effect??
There are two reasons to rebalance:

1. Moving money between assets that have different levels of risk (e.g. stocks vs bonds) ,so that your overall portfolio does not end up too risky or too conservative.

2. Selling winners and buying losers, to set yourself up for mean reversion to work in your favor.

The first reason is much more important for portfolio health than the second reason. And the first reason does not really apply in the case of rebalancing among stocks (US and Intl stocks are similarly risky). Therefore if I had no new money coming in I would not bother with rebalancing stocks.
Good response. I was wondering why would I reballance my stock funds. Just let them ride the market. One will do better than the other but then the other fund may do better next year. I am just thinking of making sure the fixed income stays at the percent I like.

Thanks
Last edited by indexonlyplease on Sun Nov 04, 2018 2:32 pm, edited 1 time in total.

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Re: Diversification Regret

Post by 3funder » Sun Nov 04, 2018 1:27 pm

vineviz wrote:
Fri Nov 02, 2018 12:40 pm
JoMoney wrote:
Fri Nov 02, 2018 12:09 pm
"Tracking error" regret is a real risk (Larry Swedroe 2012)
... Unfortunately, my experiences as both an investor and advisor have taught me that diversification isn't truly a free lunch for most investors -- with it comes the very real risk known as "tracking error regret."

Tracking error is defined as the difference between a fund or portfolio and a benchmark. Most often the benchmark is a commonly referred to index such as the S&P 500 Index. If your portfolio consists solely of an investment in an S&P 500 fund, you're not exposed to any tracking error risk. ...
Yes, and I think another implication is that in addition to thinking about "risk tolerance" (which informs the overall asset allocation) we might serve many investors better if we measure "regret tolerance" in a similar fashion.

I don't have any evidence on this, but I suspect that typically the most regret-averse investors have tended to either utilize a financial advisor (thereby delegating the decisions to a professional and proactively avoiding generating regret about their own investment choices), have invested in a manner that resembles performance chasing (i.e. continually regretting their past decisions and moving to assets that outperformed the ones they chose), or else have sat out of capital markets altogether (a behavior that resembles extreme risk-aversion but has a different psychological motivation).

My view is that regret-averse investors are possibly much better served by being encouraged to use a single balanced fund (like target date funds or Vanguard's LifeStrategy funds) rather than an unbundled collection of individual funds. Balanced fund investors are not necessarily immune from feeling regret, but they are structurally preventing themselves from acting on it to a large degree.
+1

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Re: Diversification Regret

Post by nedsaid » Sun Nov 04, 2018 2:28 pm

abuss368 wrote:
Sun Nov 04, 2018 9:45 am
nedsaid wrote:
Fri Nov 02, 2018 11:27 am
Perhaps we will be down to the Zero Fund portfolio at the rate we are going.
Hi nedsaid -

That line catches my attention every time. Well said.
It never ceases to amaze me that Bogleheads of all people fall for short termism. If a favorite asset class stops outperforming, forum members just drop it. We seem to have forgotten about diversification. The urge to "simplify" is often an acknowledgment that Large Cap Growth has been outperforming for about a decade and that everything else has been lagging. If I knew in advance which asset class would outperform over the next 20 years, I too could "simplify".

In my few years here both as a lurker and as a poster, I have seen the standard advice here drop from five funds down to two. This has happened in maybe eight years and it is alarming. The stay the course folks have not been staying the course. I have seen TIPS, REITs, and now International Stocks hit the waste bin. I am even seeing wavering on Bonds.

I am kidding somewhat about the Zero Fund portfolio but not too much. We are forgetting on this forum about diversification. If everything in your portfolio is doing well at the same time, it is a good indication that you are not diversified.
A fool and his money are good for business.

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Re: Diversification Regret

Post by JoMoney » Sun Nov 04, 2018 3:46 pm

nedsaid wrote:
Sun Nov 04, 2018 2:28 pm
abuss368 wrote:
Sun Nov 04, 2018 9:45 am
nedsaid wrote:
Fri Nov 02, 2018 11:27 am
Perhaps we will be down to the Zero Fund portfolio at the rate we are going.
Hi nedsaid -

That line catches my attention every time. Well said.
It never ceases to amaze me that Bogleheads of all people fall for short termism. If a favorite asset class stops outperforming, forum members just drop it. We seem to have forgotten about diversification. The urge to "simplify" is often an acknowledgment that Large Cap Growth has been outperforming for about a decade and that everything else has been lagging. If I knew in advance which asset class would outperform over the next 20 years, I too could "simplify".

In my few years here both as a lurker and as a poster, I have seen the standard advice here drop from five funds down to two. This has happened in maybe eight years and it is alarming. The stay the course folks have not been staying the course. I have seen TIPS, REITs, and now International Stocks hit the waste bin. I am even seeing wavering on Bonds.

I am kidding somewhat about the Zero Fund portfolio but not too much. We are forgetting on this forum about diversification. If everything in your portfolio is doing well at the same time, it is a good indication that you are not diversified.
The advice of Jack Bogle has been pretty consistent for 25+ years... it's the slice-n-dice crowd that seems to get in over their head picking "asset classes" they think are going to offer something special, then face the regret from bad benchmarking when they see their bets over-weighting small portions of the market didn't pay off.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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Re: Diversification Regret

Post by firefloat » Sun Nov 04, 2018 3:55 pm

Looking at the diversification regret chart makes me think that I shouldn't diversify as much since it doesn't look like you come out ahead.

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Re: Diversification Regret

Post by fortyofforty » Sun Nov 04, 2018 5:32 pm

nedsaid wrote:
Sun Nov 04, 2018 2:28 pm
abuss368 wrote:
Sun Nov 04, 2018 9:45 am
nedsaid wrote:
Fri Nov 02, 2018 11:27 am
Perhaps we will be down to the Zero Fund portfolio at the rate we are going.
Hi nedsaid -

That line catches my attention every time. Well said.
It never ceases to amaze me that Bogleheads of all people fall for short termism. If a favorite asset class stops outperforming, forum members just drop it. We seem to have forgotten about diversification. The urge to "simplify" is often an acknowledgment that Large Cap Growth has been outperforming for about a decade and that everything else has been lagging. If I knew in advance which asset class would outperform over the next 20 years, I too could "simplify".

In my few years here both as a lurker and as a poster, I have seen the standard advice here drop from five funds down to two. This has happened in maybe eight years and it is alarming. The stay the course folks have not been staying the course. I have seen TIPS, REITs, and now International Stocks hit the waste bin. I am even seeing wavering on Bonds.

I am kidding somewhat about the Zero Fund portfolio but not too much. We are forgetting on this forum about diversification. If everything in your portfolio is doing well at the same time, it is a good indication that you are not diversified.
I am reminded of watching Wall Street Week with Louis Rukeyser, when he would regularly interview "Gold Bug" Jim Grant. Grant assured everyone again and again that gold would have its day again. Over time, it became almost comical, like the "Elves" and their collective predictions for future stock market movements.

For the purpose of being more diversified, I suppose, one could argue that it is necessary to hold gold and precious metals. In my opinion, even though gold has tended to underperform equities, that is no reason to necessitate holding it. That would be "too much" diversification, in my opinion, without adequate justification. As I said above, I'm not convinced international equities fall into that category, but it's a close call.
"In a time of universal deceit, telling the truth becomes a revolutionary act." - George Orwell | There are many roads to doublin'. | Original Vanguard Diehard

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Re: Diversification Regret

Post by nedsaid » Sun Nov 04, 2018 6:28 pm

JoMoney wrote:
Sun Nov 04, 2018 3:46 pm
nedsaid wrote:
Sun Nov 04, 2018 2:28 pm
abuss368 wrote:
Sun Nov 04, 2018 9:45 am
nedsaid wrote:
Fri Nov 02, 2018 11:27 am
Perhaps we will be down to the Zero Fund portfolio at the rate we are going.
Hi nedsaid -

That line catches my attention every time. Well said.
It never ceases to amaze me that Bogleheads of all people fall for short termism. If a favorite asset class stops outperforming, forum members just drop it. We seem to have forgotten about diversification. The urge to "simplify" is often an acknowledgment that Large Cap Growth has been outperforming for about a decade and that everything else has been lagging. If I knew in advance which asset class would outperform over the next 20 years, I too could "simplify".

In my few years here both as a lurker and as a poster, I have seen the standard advice here drop from five funds down to two. This has happened in maybe eight years and it is alarming. The stay the course folks have not been staying the course. I have seen TIPS, REITs, and now International Stocks hit the waste bin. I am even seeing wavering on Bonds.

I am kidding somewhat about the Zero Fund portfolio but not too much. We are forgetting on this forum about diversification. If everything in your portfolio is doing well at the same time, it is a good indication that you are not diversified.
The advice of Jack Bogle has been pretty consistent for 25+ years... it's the slice-n-dice crowd that seems to get in over their head picking "asset classes" they think are going to offer something special, then face the regret from bad benchmarking when they see their bets over-weighting small portions of the market didn't pay off.
Bogle has been pretty consistent, he has been skeptical of International investing as long as I can remember. It is the forum named after him that has not been so consistent, hence my jabs about the Zero Fund portfolio. Even Taylor Larimore has dropped International Stocks and TIPS from his portfolio.

My approach has been pretty consistent over the years though I lean more and more towards the plain indexes as I get older. Never abandoned my individual stocks, my Value investments, or my earnings and price momentum funds. I probably lagged during the late 1990's internet mania as I refused to chase the hot High Tech and Internet stocks. The "lost decade" of the 2000's were actually pretty good for me as my International, Value, Mid-Small Cap, REITs, and TIPS did pretty well. I have lagged again since the financial crisis as we have been in a Large Cap Growth market.
A fool and his money are good for business.

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Re: Diversification Regret

Post by nedsaid » Sun Nov 04, 2018 6:32 pm

fortyofforty wrote:
Sun Nov 04, 2018 5:32 pm
nedsaid wrote:
Sun Nov 04, 2018 2:28 pm
abuss368 wrote:
Sun Nov 04, 2018 9:45 am
nedsaid wrote:
Fri Nov 02, 2018 11:27 am
Perhaps we will be down to the Zero Fund portfolio at the rate we are going.
Hi nedsaid -

That line catches my attention every time. Well said.
It never ceases to amaze me that Bogleheads of all people fall for short termism. If a favorite asset class stops outperforming, forum members just drop it. We seem to have forgotten about diversification. The urge to "simplify" is often an acknowledgment that Large Cap Growth has been outperforming for about a decade and that everything else has been lagging. If I knew in advance which asset class would outperform over the next 20 years, I too could "simplify".

In my few years here both as a lurker and as a poster, I have seen the standard advice here drop from five funds down to two. This has happened in maybe eight years and it is alarming. The stay the course folks have not been staying the course. I have seen TIPS, REITs, and now International Stocks hit the waste bin. I am even seeing wavering on Bonds.

I am kidding somewhat about the Zero Fund portfolio but not too much. We are forgetting on this forum about diversification. If everything in your portfolio is doing well at the same time, it is a good indication that you are not diversified.
I am reminded of watching Wall Street Week with Louis Rukeyser, when he would regularly interview "Gold Bug" Jim Grant. Grant assured everyone again and again that gold would have its day again. Over time, it became almost comical, like the "Elves" and their collective predictions for future stock market movements.

For the purpose of being more diversified, I suppose, one could argue that it is necessary to hold gold and precious metals. In my opinion, even though gold has tended to underperform equities, that is no reason to necessitate holding it. That would be "too much" diversification, in my opinion, without adequate justification. As I said above, I'm not convinced international equities fall into that category, but it's a close call.
I sold off my few gold coins in the late 1980's as I thought there were better places for my money. No doubt, gold and other precious metals act as portfolio insurance but I think the premium of performance drag isn't worth the diversification benefit. Gold and precious metals really helped in the 2000-2002 bear market but fell with everything else during 2008-2009. The insurance doesn't always work.
A fool and his money are good for business.

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Re: Diversification Regret

Post by drk » Sun Nov 04, 2018 6:46 pm

I don't understand why someone would regret a plan that was reasonable ex ante.

Then again, I've become comfortable with probability to respect the meaning of expected value, and life's taught me that regret is a fruitless activity.
vineviz wrote:
Fri Nov 02, 2018 12:40 pm
Yes, and I think another implication is that in addition to thinking about "risk tolerance" (which informs the overall asset allocation) we might serve many investors better if we measure "regret tolerance" in a similar fashion.

I don't have any evidence on this, but I suspect that typically the most regret-averse investors have tended to either utilize a financial advisor (thereby delegating the decisions to a professional and proactively avoiding generating regret about their own investment choices), have invested in a manner that resembles performance chasing (i.e. continually regretting their past decisions and moving to assets that outperformed the ones they chose), or else have sat out of capital markets altogether (a behavior that resembles extreme risk-aversion but has a different psychological motivation).

My view is that regret-averse investors are possibly much better served by being encouraged to use a single balanced fund (like target date funds or Vanguard's LifeStrategy funds) rather than an unbundled collection of individual funds. Balanced fund investors are not necessarily immune from feeling regret, but they are structurally preventing themselves from acting on it to a large degree.
I don't think I've agreed with any other opinion on this forum as vigorously as I do this one. Well put.
Last edited by drk on Sun Nov 04, 2018 6:49 pm, edited 1 time in total.

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