Sources of diversification

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adave
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Sources of diversification

Post by adave »

As a believer in modern portfolio theory, I am always looking for sources of diversification.

domestic stocks, bonds, cash, international stocks.... what else? bitcoin is unproved in terms of diversification benefit.

Real estate - already own my house.

Private investments?
delamer
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Re: Sources of diversification

Post by delamer »

International Bonds.
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toddthebod
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Re: Sources of diversification

Post by toddthebod »

A job.
alex_686
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Re: Sources of diversification

Post by alex_686 »

Alternative Investments.

Hedge funds. Private equity. Investment litigation. Hard money loans.

Basically anything that has a illiquidity premium and/or requires skill (i.e. high fees)
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
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Re: Sources of diversification

Post by nisiprius »

Remember that it is not sufficient to have "diversification" in the sense of low correlation with traditional stock/bond portfolios. The diversifier must have a reasonable return of its own--more specifically a reasonable Sharpe ratio (one measure of risk-adjusted return).

Imagine a diversifier, D, whose Sharpe ratio is lower than portfolio P. The "magic" of modern portfolio theory is that yes, it is possible for D, when added to P, to increase the Sharpe ratio of P despite having a lower Sharpe ratio itself. The problem is that this is only true under quite strict conditions. The conditions are that the correlation between D and P must be lower than the Sharpe ratio of D divided by the Sharpe ratio of P.

People often believe that there must be some improvement as long as the correlation is lower than 1.0, but this is not so. It must be lower than (Sharpe ratio of D) / (Sharpe ratio of P). This quotient tells you how low the correlation must be to get an improvement by adding D.

And, of course, even if there is an improvement it isn't necessarily large, and correlations and Sharpe ratios fluctuate just as much or more than other financial measurements. So it can be true that D would have improved P over some time period in the past, but that is no sure guarantee that it will improve it in the future. Correlations are very unstable. Chasing low correlation is the same sort of problem as chasing high return.

The devil of "sources of diversification" is that it is rare to find one that meets the test:

ρ < (Sharpe ratio of D) / (Sharpe ratio of P)

The best case is when D has low correlation with P, but also has a volatility and return that are roughly comparable to P.

In real life, people will present some asset that has been pretty fairly punk as an investment in its own right, but has had low correlation with traditional portfolios... and argue that you should not not look at it by itself, but in its effect on the portfolio as a whole. This is true enough, but merely having low correlation does not automatically mean that it will improve the portfolio as a whole.

Regardless of correlations, it is simple arithmetic that the return of a portfolio over some specified time period, e.g. a year, is just the weighted average of the individual returns of its constituent. It's sa simple as that. If D has lower return than P, adding it to P will lower the return of P, and correlations don't affect that a bit. What low correlations can do is to lower return a little while lowering the volatility a lot.

Finding diversifiers that will actually improve a portfolio is not so easy; you need more than low correlation.
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Random Musings
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Re: Sources of diversification

Post by Random Musings »

Gold, commodities.

RM
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Gaston
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Re: Sources of diversification

Post by Gaston »

nisiprius wrote: Sat May 11, 2024 8:55 pm Finding diversifiers that will actually improve a portfolio is not so easy; you need more than low correlation.
Superb post.
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Re: Sources of diversification

Post by alex_686 »

Gaston wrote: Sat May 11, 2024 9:22 pm
nisiprius wrote: Sat May 11, 2024 8:55 pm Finding diversifiers that will actually improve a portfolio is not so easy; you need more than low correlation.
Superb post.
Not necessarily.

Gold has no source of return. However it has a high volatility, low correlation, and mean reverts. As such it generates a rebalancing bonus. If you are using a convex rebalancing strategy such as a constant mix strategy.

And yes, you must meet those 4 criteria. And get that deep into the weeds.
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Gaston
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Re: Sources of diversification

Post by Gaston »

Random Musings wrote: Sat May 11, 2024 9:22 pm Gold, commodities.
Help me understand this please. Nisiprius’s first point is that “it is not sufficient to have diversification in the sense of low correlation with traditional stock/bond portfolios. The diversifier must have a reasonable return of its own.”

When I run 30-year backtests on gold and commodity funds (eg, GLD and DBC), I don’t see that they have a “reasonable return on their own”.

I do see that they have low correlation with the S&P 500, but they seem to really drag down total return (eg, VFINX + GLD). Am I missing something?
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Re: Sources of diversification

Post by TheRoundHeadedKid »

Invest like an endowment. "Endowments allocate the largest percentages of their portfolios to alternative asset classes like hedge funds, private equity, venture capital, and real assets like oil and other natural resources.", from https://www.investopedia.com/articles/f ... gement.asp
All 86 Vanguard ETFs equally invested.
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Re: Sources of diversification

Post by heyyou »

Warning: This rant is only tied into the topic of this thread, on my final two sentences. Patiently tolerating the markets' fluctuations has worked better for me, than trying to allocate to avoid deeper fluctuations. With my RMD % of portfolio retirement spending method, I just accept some fluctuation in my income instead of striving to avoid those fluctuations.

I did better with delayed gratification and trying to save most of each after-tax pay raise, than I did on trying to follow up on what the academics published on portfolio theory. Whatever I changed when trying for more performance per new research, seemed like the past performance didn't ever repeat.

The worst one was Larry Swedroe's touting of the Princeton professors' commodities research on petroleum futures which showed what would have done very well, but that did not ever repeat with their new PCRIX commodities futures fund, because the fund's futures trades were easily front run by the commodity traders who could see the renewal dates on those large expiring futures' positions. That failed diversification of my portfolio cost me 10% of its value and stalled my early retirement for several years. Thus, I'm not a believer in further diversification than just broad stock and bond index funds with a sliver of gold exposure.
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Re: Sources of diversification

Post by Dpmbball »

adave wrote: Sat May 11, 2024 6:45 pm As a believer in modern portfolio theory, I am always looking for sources of diversification.

domestic stocks, bonds, cash, international stocks.... what else? bitcoin is unproved in terms of diversification benefit.

Real estate - already own my house.

Private investments?
Investing in a business you operate or others operate for you as owner … This helps with tax deductions…life settlement for elder with life insurance policies
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Re: Sources of diversification

Post by nisiprius »

Gaston wrote: Sat May 11, 2024 10:11 pm
Random Musings wrote: Sat May 11, 2024 9:22 pm Gold, commodities.
Help me understand this please. Nisiprius’s first point is that “it is not sufficient to have diversification in the sense of low correlation with traditional stock/bond portfolios. The diversifier must have a reasonable return of its own.”

When I run 30-year backtests on gold and commodity funds (eg, GLD and DBC), I don’t see that they have a “reasonable return on their own”.

I do see that they have low correlation with the S&P 500, but they seem to really drag down total return (eg, VFINX + GLD). Am I missing something?
Best if you show the actual time period. These things usually fall down the rabbit hole of specific endpoints and specific time periods. The problem with judging the usefulness of things like commodities and gold is that they are even "burstier" than stocks and bonds, so the endpoint dependence is even stronger. The bursts are so large that they can drag very long averages up or down enough matter, and so rare that it is all handwaving whether you can count on capturing one of them during an individual retirement savings program.
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Re: Sources of diversification

Post by CloseEnough »

Rare Italian violins.
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Re: Sources of diversification

Post by seajay »

adave wrote: Sat May 11, 2024 6:45 pm As a believer in modern portfolio theory, I am always looking for sources of diversification.

domestic stocks, bonds, cash, international stocks.... what else? bitcoin is unproved in terms of diversification benefit.

Real estate - already own my house.

Private investments?
Buy and hold is no different to the costless lumping in each and every day. So tomorrow many might "buy" into sizable amounts of home/stocks/bonds/gold .... whatever assets. And additionally spend a relatively small amount of that total wealth on consumer goods/products/services. For us a UK home, US stocks, gold asset allocation preference = three currencies, three assets, two in-hand (the other one with T+2 liquidity time), mostly matches our personal inflation rate (of predominately UK house prices, US stock prices, gold). Factoring in additional imputed rent and dividend benefits and a upward sloping near 4% real trend line with very low volatility compared to a inflation rate of average(house,stock,gold,CPI) price increases. Historically that personal inflation rate exceeded just CPI inflation rate by near 2%. We prefer gold to bonds as we also have pensions income - that might be considered as a form of inflation bond ladder that precisely exhausts/expires the day you die.
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Re: Sources of diversification

Post by seajay »

Gaston wrote: Sat May 11, 2024 10:11 pm
Random Musings wrote: Sat May 11, 2024 9:22 pm Gold, commodities.
Help me understand this please. Nisiprius’s first point is that “it is not sufficient to have diversification in the sense of low correlation with traditional stock/bond portfolios. The diversifier must have a reasonable return of its own.”

When I run 30-year backtests on gold and commodity funds (eg, GLD and DBC), I don’t see that they have a “reasonable return on their own”.

I do see that they have low correlation with the S&P 500, but they seem to really drag down total return (eg, VFINX + GLD). Am I missing something?
Gold might broadly offset inflation over the long term, as might share prices (and where shares additionally pay dividends). Blending some of both foregoes part of the dividends, but where inverse correlations/volatility can yield a form of 'dividend' in itself such as reducing SoR risk.

Over some periods drawing a decent SWR from gold worked OK when otherwise drawing a SWR from stocks faltered. 2000 to 2009 and 500K in gold, 40K SWR was fine over a period when it would have been best to just leave stocks as-is (accumulating dividends, no withdrawals).

https://www.portfoliovisualizer.com/bac ... Mfje53VJsn

Over other periods that flips around, leave gold as-is, draw SWR from stocks that are performing well.

Or partial amounts from each.

There are three main sources of rewards, price appreciation, income/interest, volatility capture. Different investors might target one of those alone, Options traders for instance might specifically target volatility. Broadly each should compare in level of rewards as if that were not the case investors would concentrate into the single consistently best choice.
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Re: Sources of diversification

Post by Logan Roy »

Gaston wrote: Sat May 11, 2024 10:11 pm
Random Musings wrote: Sat May 11, 2024 9:22 pm Gold, commodities.
Help me understand this please. Nisiprius’s first point is that “it is not sufficient to have diversification in the sense of low correlation with traditional stock/bond portfolios. The diversifier must have a reasonable return of its own.”

When I run 30-year backtests on gold and commodity funds (eg, GLD and DBC), I don’t see that they have a “reasonable return on their own”.

I do see that they have low correlation with the S&P 500, but they seem to really drag down total return (eg, VFINX + GLD). Am I missing something?
The problem with a 30 year backtest is it only gives you a falling rates and inflation environment, up until very recently (and then you get a few years of rates and inflation going the other way, and an AI boom).

So if we were to build a portfolio for this environment, then find ourselves with rising rates and inflation, and slowing growth (just as common an environment), we wouldn't really have a tested strategy at all. It would be like safety testing a car without ever driving it in the rain.

Gold and commodities should generate a rate of return (through capital appreciation) similar to inflation. Probably a higher return than cash over meaningful periods, and potentially a higher return than bonds (when global debt levels kind of necessitate negative real yields – so the cost of refinancing debt doesn't start to drag on the economy) .. If debt refinancing does drag on the economy, gold tends to do well as a haven and dollar hedge. If inflation picks up because central banks have to buy all the low yielding debt, then gold and commodities may do well as inflation hedges. There are a lot of reasons gold (at least) makes sense as a diversifier, and even quite large allocations over the past 40-50 years have often improved returns over 100% equities (but that's partly down to gold far outpacing its usual inflation-like return, so not necessarily a good thing),
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Re: Sources of diversification

Post by TimeIsYourFriend »

Gold: you get the volatility of equities with the return of 0% TIPS over hundreds of years.
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Logan Roy
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Re: Sources of diversification

Post by Logan Roy »

TimeIsYourFriend wrote: Sun May 12, 2024 9:20 am Gold: you get the volatility of equities with the return of 0% TIPS over hundreds of years.
But you tend to get that return at the right moments..

TIPS on positive yields make more sense as investments; but gold often makes more sense as a diversifier .. Strong dollar and economy often gives you opportunities to add to gold at depressed prices, then weak economy gives you something to sell at high prices.

I'm cautious on how much gold's exceeded inflation for 40-50 years, but anyone who allocated to it and held meaningfully over the half century's certainly been rewarded with smoother and potentially higher returns. Also nice to have a way to diversify outside financial assets, with liquidity.
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Re: Sources of diversification

Post by stan1 »

Commodities/currencies: you need to successfully market time at least on the buy side, on sell side too if you want to make money. Rebalancing isn't enough and ideally in tax advantaged account. Market timing difficult to do.

Owning and renting out real estate. Not the same as REIT or owning your personal residence and a vacation home.
Owning a business that generates income for the owner(s)
Monetizing your intellectual capacity, skills and abilities (aka work compensated at market rate for an expert in your field)
Work at a startup with total comp tied to success of company

Factors if they exist, are persistent, and can be captured going forward. Potential for uncompensated risk.
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Re: Sources of diversification

Post by nisiprius »

Logan Roy wrote: Sun May 12, 2024 9:32 am
TimeIsYourFriend wrote: Sun May 12, 2024 9:20 am Gold: you get the volatility of equities with the return of 0% TIPS over hundreds of years.
But you tend to get that return at the right moments...
Except investors haven't. The worst inflation in the history of the CPI occurred from 6/30/1915 to 6/30/1920, while the United States was on the gold standard. Prices in dollars more than doubled in five years. Since the US was on the gold standard, if gold value spiked whenever inflation spiked, the value of the dollar should have spiked as well, but it didn't.

Conversely, the price of gold quadrupled from 2005 to 2011 although inflation remained low and stable. You may say that's a good problem for gold investors to have, but it's not good if the narrative is that gold gets high return at the "right" moments.

And gold also failed to spike in 2022.

Summarizing:

1915-1920, gold failed to spike when needed.
Around 1980, gold spiked just when needed.
2005-2011, gold spiked when not needed.
2022, gold failed to spike when needed.

It lived up to the "when needed" claim one time in four.
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Re: Sources of diversification

Post by unwitting_gulag »

nisiprius wrote: Sun May 12, 2024 5:35 am
Gaston wrote: Sat May 11, 2024 10:11 pm
Random Musings wrote: Sat May 11, 2024 9:22 pm Gold, commodities.
Help me understand this please. Nisiprius’s first point is that “it is not sufficient to have diversification in the sense of low correlation with traditional stock/bond portfolios. The diversifier must have a reasonable return of its own.”

When I run 30-year backtests on gold and commodity funds (eg, GLD and DBC), I don’t see that they have a “reasonable return on their own”.

I do see that they have low correlation with the S&P 500, but they seem to really drag down total return (eg, VFINX + GLD). Am I missing something?
Best if you show the actual time period. These things usually fall down the rabbit hole of specific endpoints and specific time periods. The problem with judging the usefulness of things like commodities and gold is that they are even "burstier" than stocks and bonds, so the endpoint dependence is even stronger. The bursts are so large that they can drag very long averages up or down enough matter, and so rare that it is all handwaving whether you can count on capturing one of them during an individual retirement savings program.
One supposes that the magic of such diversification is with rebalancing. If gold merely holds its value in tumultuous time, when bonds and equities both fall, then the diversified investor gets to rebalance back into the beaten-down stocks and bonds, by selling a portion of the gold. Then if stocks have a spectacular year, the same formula implies a selling of some of stocks, buying more gold. Thus the "permanent portfolio" and its variants, such as the Golden Butterfly, assume regular rebalancing.

The rebalancing is touted as being free of the taint of market timing, because it is done regularly, say on the 15 of every fourth month. It is not driven by just having an upswell in stock prices, with some desire to "lock in profits". But to me it's a red herring. Any selling of winners and buying of losers, is a bet on reversion to the mean, where those who were last, shall eventually be first. How isn't that market timing?

Could some computer-savvy person please post a backtest of the Permanent Portfolio using Portfolio Visualizer, in two forms: one with quarterly rebalancing, and one with never rebalancing? The difference should be substantial.
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Re: Sources of diversification

Post by Logan Roy »

nisiprius wrote: Sun May 12, 2024 1:50 pm
Logan Roy wrote: Sun May 12, 2024 9:32 am
TimeIsYourFriend wrote: Sun May 12, 2024 9:20 am Gold: you get the volatility of equities with the return of 0% TIPS over hundreds of years.
But you tend to get that return at the right moments...
Except investors haven't. The worst inflation in the history of the CPI occurred from 6/30/1915 to 6/30/1920, while the United States was on the gold standard. Prices in dollars more than doubled in five years. Since the US was on the gold standard, if gold value spiked whenever inflation spiked, the value of the dollar should have spiked as well, but it didn't.

Conversely, the price of gold quadrupled from 2005 to 2011 although inflation remained low and stable. You may say that's a good problem for gold investors to have, but it's not good if the narrative is that gold gets high return at the "right" moments.

And gold also failed to spike in 2022.

Summarizing:

1915-1920, gold failed to spike when needed.
Around 1980, gold spiked just when needed.
2005-2011, gold spiked when not needed.
2022, gold failed to spike when needed.

It lived up to the "when needed" claim one time in four.
Gold's relationship to inflation is long-term. It's been drifting off that course since the 1970s. It's primarily just demand-based. Incidentally, if you were looking at inflation, I'd have thought the 1970s pretty useful to have in a summary.

Gold's more immediate relationship is with the dollar. A strong dollar means a strong economy – so gold acts as a heatsink, when rebalanced against growth assets. That energy's then released when things reverse .. It's not a perfectly inverse relationship – the fact gold still tracks inflation over the long-term means it's a hedge that doesn't really cost you anything to hold (unlike cash).

A more practical demonstration, I think, is how something like 75:25 stocks/gold has improved risk-adjusted returns of stocks while maintaining a total return comparable to 100% stocks. We can say it's dependent on start and end points, but PortfolioCharts' rolling start and end points demonstrate the same consistency in providing diversification at about the right times.

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Re: Sources of diversification

Post by toddthebod »

Logan Roy wrote: Sun May 12, 2024 3:04 pm A more practical demonstration, I think, is how something like 75:25 stocks/gold has improved risk-adjusted returns of stocks while maintaining a total return comparable to 100% stocks. We can say it's dependent on start and end points, but PortfolioCharts' rolling start and end points demonstrate the same consistency in providing diversification at about the right times.

Image
Change the starting year to 1975.
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Re: Sources of diversification

Post by unwitting_gulag »

Logan Roy wrote: Sun May 12, 2024 3:04 pm A more practical demonstration, I think, is how something like 75:25 stocks/gold has improved risk-adjusted returns of stocks while maintaining a total return comparable to 100% stocks. We can say it's dependent on start and end points, but PortfolioCharts' rolling start and end points demonstrate the same consistency in providing diversification at about the right times.
Is this with rebalancing? If you would, please post the link to your Portfolio Visualizer results, so that we could play with the settings.
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Re: Sources of diversification

Post by KlangFool »

adave wrote: Sat May 11, 2024 6:45 pm
As a believer in modern portfolio theory, I am always looking for sources of diversification.
viewtopic.php?t=431448

adave,

From your other thread, you are 5% cash and 95% stock. You do not believe in bond.

So, if you do not believe in bond, how could you believe in anything else?

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Re: Sources of diversification

Post by toddthebod »

unwitting_gulag wrote: Sun May 12, 2024 4:14 pm
Logan Roy wrote: Sun May 12, 2024 3:04 pm A more practical demonstration, I think, is how something like 75:25 stocks/gold has improved risk-adjusted returns of stocks while maintaining a total return comparable to 100% stocks. We can say it's dependent on start and end points, but PortfolioCharts' rolling start and end points demonstrate the same consistency in providing diversification at about the right times.
Is this with rebalancing? If you would, please post the link to your Portfolio Visualizer results, so that we could play with the settings.
It's all default settings.
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Re: Sources of diversification

Post by UpperNwGuy »

adave wrote: Sat May 11, 2024 6:45 pm As a believer in modern portfolio theory, I am always looking for sources of diversification.

domestic stocks, bonds, cash, international stocks.... what else? bitcoin is unproved in terms of diversification benefit.

Real estate - already own my house.

Private investments?
I am confused by this post. A few days earlier you asked us if 95% VTI and 5% cash would be a good portfolio. You seemed to be heading down that road. What changed?
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Re: Sources of diversification

Post by Jack FFR1846 »

I think you need to state exactly what your current diversification is and then state why you feel you need more diversification and finally state what return these diversifying must return.

I want an investment that will never go down, isn't tied to stocks, isn't tied to bonds and delivers a return somewhat lower than bonds do. I choose iBonds. If you require all this but higher returns than stocks, I'd say "Good Luck".

Perhaps you want a return similar to stocks and currently have only the S&P 500. Well, mid and small cap stocks, international stocks are pretty good diversifiers.

If you think Bitcoin is an investment worth considering, I'd say that its primary purpose is for cash alternatives in payments. Excellent in sales of illegal things or services. So rather than some crypto, why not the Yen or the Pound or the Canadian dollar?
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adave
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Re: Sources of diversification

Post by adave »

UpperNwGuy wrote: Sun May 12, 2024 4:21 pm
adave wrote: Sat May 11, 2024 6:45 pm As a believer in modern portfolio theory, I am always looking for sources of diversification.

domestic stocks, bonds, cash, international stocks.... what else? bitcoin is unproved in terms of diversification benefit.

Real estate - already own my house.

Private investments?
I am confused by this post. A few days earlier you asked us if 95% VTI and 5% cash would be a good portfolio. You seemed to be heading down that road. What changed?
I am sitting on about 1.2M in cash I can invest and considering muni bonds vs just dump into VTI and increase cash reserves
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Re: Sources of diversification

Post by adave »

VTI has a high chance of outperforming but muni bonds would provide real diversification benefit.

At the moment I am 48 yr old and in good health with a stable job in medicine, but things can change unexpectedly in life.
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Re: Sources of diversification

Post by adave »

My logical side tells me it is time to de-risk the portfolio a little and add bonds. However I also feel I would be comfortable with a larger cash cushion and let the rest ride in index ETFs, VTI, VXUS, VGT etc
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Re: Sources of diversification

Post by watchnerd »

adave wrote: Sat May 11, 2024 6:45 pm As a believer in modern portfolio theory, I am always looking for sources of diversification.

domestic stocks, bonds, cash, international stocks.... what else? bitcoin is unproved in terms of diversification benefit.

Real estate - already own my house.

Private investments?
Bonds splits up into a lot of sub-groups with differing degrees of risk factors such as credit risk.

Instead of viewing bonds as a 'risk free' asset and sticking to flavors of Treasuries, one can embrace IG, High Yield, EM debt, etc.

Collectibles are another area for possible diversification.
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Re: Sources of diversification

Post by Beensabu »

Gaston wrote: Sat May 11, 2024 10:11 pm Am I missing something?
You either turned off rebalancing or added cashflows.

Pure US stock market with regular contributions post-GFC has outperformed just about every combo that included something else.
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Re: Sources of diversification

Post by Logan Roy »

toddthebod wrote: Sun May 12, 2024 4:06 pm
Logan Roy wrote: Sun May 12, 2024 3:04 pm A more practical demonstration, I think, is how something like 75:25 stocks/gold has improved risk-adjusted returns of stocks while maintaining a total return comparable to 100% stocks. We can say it's dependent on start and end points, but PortfolioCharts' rolling start and end points demonstrate the same consistency in providing diversification at about the right times.

Image
Change the starting year to 1975.
Read my post.
Florida Orange
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Re: Sources of diversification

Post by Florida Orange »

Gold has no internal rate of return. To make money with gold you have to rely on the greater fool theory. You have to find somebody who is an even greater fool than you are and who will pay even more for it than you did.
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Re: Sources of diversification

Post by Logan Roy »

unwitting_gulag wrote: Sun May 12, 2024 4:14 pm
Logan Roy wrote: Sun May 12, 2024 3:04 pm A more practical demonstration, I think, is how something like 75:25 stocks/gold has improved risk-adjusted returns of stocks while maintaining a total return comparable to 100% stocks. We can say it's dependent on start and end points, but PortfolioCharts' rolling start and end points demonstrate the same consistency in providing diversification at about the right times.
Is this with rebalancing? If you would, please post the link to your Portfolio Visualizer results, so that we could play with the settings.
Here's a link. All default.
https://www.portfoliovisualizer.com/bac ... 948BDYLv5R

If I turn off rebalancing, the return drops from 10.76% to 10.11%, and you get the same (i.e. weaker) Sharpe ratio as 100% stocks .. Without rebalancing, or some kind of tactical allocation, you just get two assets drifting .. Gold's strength is in storing and releasing value – otherwise it's just a bet on gold going up (which it doesn't have to, long-term, to be a good diversifier).
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Re: Sources of diversification

Post by Logan Roy »

Florida Orange wrote: Sun May 12, 2024 7:06 pm Gold has no internal rate of return. To make money with gold you have to rely on the greater fool theory. You have to find somebody who is an even greater fool than you are and who will pay even more for it than you did.
Another way to look at it is cash and bonds have no real value at all. Every cash and bond transaction relies on a greater fool. Every time central banks print more, the value of all those in existence gets a step closer to zero. And while they pay interest, they're paying you in something imaginary, that they're creating out of thin air.

When it comes down to it – when the system crashes, when there's global conflict, when we get runaway inflation – there'll be those holding something real, that there's a fixed amount of, that's been traded for millennia, and there'll be those only holding Monopoly money .. and we're supposed to believe the former is the fool, because gold doesn't pay interest, or something.
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Re: Sources of diversification

Post by toddthebod »

Logan Roy wrote: Sun May 12, 2024 6:58 pm
toddthebod wrote: Sun May 12, 2024 4:06 pm
Logan Roy wrote: Sun May 12, 2024 3:04 pm A more practical demonstration, I think, is how something like 75:25 stocks/gold has improved risk-adjusted returns of stocks while maintaining a total return comparable to 100% stocks. We can say it's dependent on start and end points, but PortfolioCharts' rolling start and end points demonstrate the same consistency in providing diversification at about the right times.

Image
Change the starting year to 1975.
Read my post.
I did, your comparison was meaningless. Nobody invests one time at the beginning of their career and never saves another penny. Add annual contributions, and no matter what year you start your analysis, the 75:25 portfolio falls substantially behind the 100% stock portfolio, to the tune of having a third less money after 30 years. Even more telling, switch gold for 10 year Treasuries, and you end up ahead as well.
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Re: Sources of diversification

Post by Random Musings »

Gaston wrote: Sat May 11, 2024 10:11 pm
Random Musings wrote: Sat May 11, 2024 9:22 pm Gold, commodities.
Help me understand this please. Nisiprius’s first point is that “it is not sufficient to have diversification in the sense of low correlation with traditional stock/bond portfolios. The diversifier must have a reasonable return of its own.”

When I run 30-year backtests on gold and commodity funds (eg, GLD and DBC), I don’t see that they have a “reasonable return on their own”.

I do see that they have low correlation with the S&P 500, but they seem to really drag down total return (eg, VFINX + GLD). Am I missing something?
With respect to the thread, the ask was to suggest diversifiers for portfolio construction. The question is if some asset classes are diworseifiers and should be avoided. There have been prior threads on gold and commodities on this site, and how they are viewed (I'd say that commodities are considered less as an option compared to gold on this site).

However, you see current threads where certain members eschew the use of international equities (underperforming for a decent stretch, domestic equities have international reach so really don't need it) and others where other asset classes will be avoided. Now, cash has been a topic on the rise as well as TIPs (there is always the nominal vs real debate).

Saying that, what asset classes are chosen by each investor on this board is based upon what they find comfort in. The biggest key is to stick to your written plan. Asset classes I use are domestic and international equities (with some small-value tilt), domestic nominal Treasury bonds (short term duration, mulling over increasing duration), domestic real bonds (ST funds as well as a partial TIPs ladder that I have built recently as preparation for retirement), some cash and some gold (5%). IMHO, using cash as part of the bond side essentially reduces your overall bond duration. I do not utilize REITs, international bonds or commodities and have no plans to do so. Nisiprius's comments about the "burstiness" of gold and commodities are historically evident and I am quite aware of that as I work for a commodities company (one if the reasons I don't use commodities).

After careful consideration and looking at the potential advantages and pitfalls of using gold as a diversifier, I decided to jump in the pool (certainly not the deep end, and took that 5% away from both stocks and bonds) around 2015 and was promptly rewarded with about a 20% drop in price. I have stayed the course, and have had one rebalancing occurance so far.

RM
I figure the odds be fifty-fifty I just might have something to say. FZ
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Re: Sources of diversification

Post by seajay »

Florida Orange wrote: Sun May 12, 2024 7:06 pm To make money with gold you have to rely on the greater fool theory. You have to find somebody who is an even greater fool than you are and who will pay even more for it than you did.
Gold is multifaceted, is a collectible, jewelry, a global currency, a commodity and is divisible/fungible. Favored by some for its relatively small size (weight) to value and being a non harmful solid. Average-in over many years and sooner or later some "fool" will buy it from you for more than the average price you paid for it. JP Morgan described it to Congress as being "Money, everything else is credit".

As money other asset prices have been pretty wild, Dow stock index shares for instance

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(Dow/gold ratio)

In February 1980 a Dow stock index share cost 1.30 ounces of gold, in July 1999 the same Dow share cost 41.61 ounces of gold. Yes a selective with hindsight trough to peak time period, but perhaps at least one investor may actually have bought a Dow share for 1.3 ounces of gold in 1980 and sold that share for 41.61 ounces of gold in 1999, annualized around 19% over the 20 odd year period. Similarly another investor might have achieved the complete opposite extreme. Volatile/variable rewards (losses), as can stocks gain/lose a lot. Being multifaceted however and the tendency is to see its volatile price motion follow a different transition/motion to other assets. When the dollar relatively declines for instance the price of gold in being a global currency might spike. At times when art/collectibles might be more popular so also might gold ...etc. Combining/blending multiple high volatility assets has the tendency to reduce overall portfolio volatility.

Some like to more broadly diversify their portfolio and perhaps separately hold paintings or other art, commodities and/or a foreign currency, me - I have no eye for art and prefer a global currency to that of any one specific alternative choice, and I'd rather carry a bar of gold than the back breaking equivalent value weight of silver or whatever. $1 milllion in dollar bills weighs 1000kg, $1 million in gold recently weighs 13.2kg. Even in $50 bills they weigh near 7kg more than gold.
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Re: Sources of diversification

Post by halfnine »

adave wrote: Sat May 11, 2024 6:45 pm As a believer in modern portfolio theory, I am always looking for sources of diversification.

domestic stocks, bonds, cash, international stocks.... what else? bitcoin is unproved in terms of diversification benefit.

Real estate - already own my house.

Private investments?
- Equities
- Fixed income
- Real estate (inclusive of home ownership)
- Human capital / social security / annuities (I put these in these all in the same category since typically as human capital decreases it is replaced by future SS, etc)
- Gold (5-10%)

My feeling is that as long as one of the main categories above doesn't completey dominate all the rest you are probably going to be alright. Now, you probably won't be hitting it out of the park but you won't be striking out at the plate either. To further eliminate country risk, weakening currency, etc. increase international holdings. If you are concerned about Deep Risk the next step would be to move a portion of your assets abroad. And the final step would be establishing residency rights or citizenship in another country.
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Re: Sources of diversification

Post by watchnerd »

Florida Orange wrote: Sun May 12, 2024 7:06 pm Gold has no internal rate of return. To make money with gold you have to rely on the greater fool theory. You have to find somebody who is an even greater fool than you are and who will pay even more for it than you did.
This is also true for Picasso paintings.
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Re: Sources of diversification

Post by Florida Orange »

watchnerd wrote: Mon May 13, 2024 1:07 am
Florida Orange wrote: Sun May 12, 2024 7:06 pm Gold has no internal rate of return. To make money with gold you have to rely on the greater fool theory. You have to find somebody who is an even greater fool than you are and who will pay even more for it than you did.
This is also true for Picasso paintings.
True, but at least some people enjoy looking at Picasso paintings. Gold has no utility.
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Re: Sources of diversification

Post by dcabler »

adave wrote: Sat May 11, 2024 6:45 pm As a believer in modern portfolio theory, I am always looking for sources of diversification.

domestic stocks, bonds, cash, international stocks.... what else? bitcoin is unproved in terms of diversification benefit.

Real estate - already own my house.

Private investments?
I always liked the concept of the diversification ratio, which has been discussed on this forum. It's a measure of the weighted average of the volatility of each component in a portfolio to the volatility of the entire portfolio itself. To make the calculation properly you need the historical volatility of each component in a portfolio as well as their correlations.

General Topic on the concept: viewtopic.php?t=251043
Post with a link to a spreadsheet that can be used to make the calculation: viewtopic.php?p=4448502#p4448502

By this measure, at least from a mathematical sense, you can increase the diversification of a portfolio by adding any asset that has a correlation of less than 1.0. From a practical sense, you're not going to see much improvement if, for example, you're adding an asset with a correlation of 0.95 to the other assets.

Because many investors would like to see both high returns and high diversification, the goal would be to seek those assets with good long term returns and mutually low correlations. Good luck with that. To improve diversification by this measure beyond a certain point would likely require giving up some amount of returns to achieve it.

Of course this is all measured by looking backwards, correlations can change over time and for long periods of time as can returns, future might not be like the past, yada yada....

Cheers.

 
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Re: Sources of diversification

Post by watchnerd »

Florida Orange wrote: Mon May 13, 2024 4:27 am
watchnerd wrote: Mon May 13, 2024 1:07 am
Florida Orange wrote: Sun May 12, 2024 7:06 pm Gold has no internal rate of return. To make money with gold you have to rely on the greater fool theory. You have to find somebody who is an even greater fool than you are and who will pay even more for it than you did.
This is also true for Picasso paintings.
True, but at least some people enjoy looking at Picasso paintings. Gold has no utility.
People enjoy wearing gold jewelry.

If Picasso paintings meet that definition of utility, I would say gold does, too.
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Re: Sources of diversification

Post by CloseEnough »

watchnerd wrote: Mon May 13, 2024 8:28 am
Florida Orange wrote: Mon May 13, 2024 4:27 am
watchnerd wrote: Mon May 13, 2024 1:07 am
Florida Orange wrote: Sun May 12, 2024 7:06 pm Gold has no internal rate of return. To make money with gold you have to rely on the greater fool theory. You have to find somebody who is an even greater fool than you are and who will pay even more for it than you did.
This is also true for Picasso paintings.
True, but at least some people enjoy looking at Picasso paintings. Gold has no utility.
People enjoy wearing gold jewelry.

If Picasso paintings meet that definition of utility, I would say gold does, too.
Check out rare Italian violins. Utility, great returns, supply/demand curve is right and diversifies. Perfect. Lots of fakes though :happy And helps if you are a violinist.
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Re: Sources of diversification

Post by seajay »

Florida Orange wrote: Mon May 13, 2024 4:27 am
watchnerd wrote: Mon May 13, 2024 1:07 am
Florida Orange wrote: Sun May 12, 2024 7:06 pm Gold has no internal rate of return. To make money with gold you have to rely on the greater fool theory. You have to find somebody who is an even greater fool than you are and who will pay even more for it than you did.
This is also true for Picasso paintings.
True, but at least some people enjoy looking at Picasso paintings. Gold has no utility.
However a Picasso painting isn't divisible or fungible. Near instant moving physical gold from one country vault to another may end up with different actual gold - but makes no difference. Each diversifier may have different characteristics (risks/benefits) to others, that's a primary reason to diversify, concentration risk is a major risk factor that's easily diluted.
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Re: Sources of diversification

Post by Florida Orange »

seajay wrote: Mon May 13, 2024 8:33 am
Florida Orange wrote: Mon May 13, 2024 4:27 am
watchnerd wrote: Mon May 13, 2024 1:07 am
Florida Orange wrote: Sun May 12, 2024 7:06 pm Gold has no internal rate of return. To make money with gold you have to rely on the greater fool theory. You have to find somebody who is an even greater fool than you are and who will pay even more for it than you did.
This is also true for Picasso paintings.
True, but at least some people enjoy looking at Picasso paintings. Gold has no utility.
However a Picasso painting isn't divisible or fungible. Near instant moving physical gold from one country vault to another may end up with different actual gold - but makes no difference. Each diversifier may have different characteristics (risks/benefits) to others, that's a primary reason to diversify, concentration risk is a major risk factor that's easily diluted.
Diversification is important up to a point. But that doesn't mean there's no such thing as a bad investment. Something like stocks or bonds which have an internally generated source of revenue or land and buildings which can be used for practical purposes, strike me as a much better way to diversify than gold which only has value because everybody thinks that everybody else thinks it has value and they therefore assume that people will continue to pay more for it than can be rationally justified. The same can be said of rare stamps. What if everybody lost interest in rare stamps and no one was willing to pay anything for them? They have no inherent value. They're only worth a lot because some people are willing to pay an irrational amount for them. When you use gold as a diversifier you're betting that people will continue to honor the polite fiction that it's a valuable commodity.
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Re: Sources of diversification

Post by watchnerd »

Florida Orange wrote: Mon May 13, 2024 9:04 am Diversification is important up to a point. But that doesn't mean there's no such thing as a bad investment. Something like stocks or bonds which have an internally generated source of revenue or land and buildings which can be used for practical purposes, strike me as a much better way to diversify than gold which only has value because everybody thinks that everybody else thinks it has value and they therefore assume that people will continue to pay more for it than can be rationally justified. The same can be said of rare stamps. What if everybody lost interest in rare stamps and no one was willing to pay anything for them? They have no inherent value. They're only worth a lot because some people are willing to pay an irrational amount for them. When you use gold as a diversifier you're betting that people will continue to honor the polite fiction that it's a valuable commodity.
Actually, speculating on gold price action isn't central investment rationale for many long term gold holders.

It's not to swing trade gold, but to hold gold as an offset to fiat currency debasement.

As far as the polite fiction that it's a valuable commodity, many central banks (including The Fed) still buy/sell and hold gold reserves.
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