Is being in a world index fund true diversification?

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artfulinvestor83
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Is being in a world index fund true diversification?

Post by artfulinvestor83 » Sun Mar 01, 2020 4:05 am

Hi folks,

The equities part of my portfolio is all in a world fund index. I understand this gives me exposure more or less to the entire global equity market, depending on the specific index fund, and that I want this diversification because I don't want all my eggs in one basket. Just because one country or region has done well historically does not mean it will continue to. With this principle I am fully bought in.

One nagging issue that I can't get my head around though is that in these world funds the US equity share makes up 55%-65% of the whole fund and so if the US does poorly my whole fund does poorly even if another part does really well. The other parts may minimise my overall loss but won't be enough to counter the loss if the US falls because it makes up such a big part.

So therefore am I truly diversified?

I understand why the fund is market cap weighted per country, and the idea that you trust in an efficient market, and so as countries rise and fall their share within the fund will change. If I decide to overweight French stocks in relation to their market size ratio then I am saying that I know something more than the market, and have an edge that they will do better, and that is not wise because I do NOT know better than the market and I do not have an edge.

But again the same problem comes to me which is if in the next 20-30 years the US has terrible equity returns, but Europe does really well, I would still have done poorly with my fund, because so much of it was made up by US stocks (55%-65%), whereas only 10%-15% was made of European stocks, so this growing part wouldn't make up for the poor performance in the largest part. So my instincts say shouldn't I have an equity portfolio that is not country market cap weighted but rather equally divided by the main regions of the world with no single country's equities forming more than 10% of the portfolio.

This is true diversification because I'm saying I don't know which region will have the best performance going forward so I want equal exposure to all of them.

I know the consensus is that US stocks will have the best performance but no-one knows this. In 1990 the consensus was that Japan would overtake the US but then their bear market started in that same year and they still haven't recovered. 30 years later! Why can't the same happen to the US?
Last edited by artfulinvestor83 on Thu Mar 05, 2020 3:17 pm, edited 1 time in total.

theorist
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Re: Is being in a world index fund true diversification?

Post by theorist » Sun Mar 01, 2020 5:11 am

artfulinvestor83 wrote:
Sun Mar 01, 2020 4:05 am

I know the consensus is that US stocks will have the best performance but no-one knows this. In 1990 the consensus was that Japan would overtake the US but then their bear market started in that same year and they still haven't recovered. 30 years later! Why can't the same happen to the US?
It can. No one knows the future. Many US residents hold only 20% international (from our perspective) equities or even less, and consider themselves sufficiently diversified. While past results after the last decade & performance chasing smile upon that approach, it could fail badly in the next few decades. Or be a winning approach again. A similar Eurocentric or ex-US centric view — with in your case 25% US and 75% ex-US — is no less justified on a purely theoretical basis, given common assumptions.

In fact, forecasts of serious people, e.g. Vanguard

https://advisors.vanguard.com/iwe/pdf/FAVEMOSP.pdf

are strongly encouraging US investors to up their allocations to international stocks. While no one can predict the future, Vanguard clearly forecasts higher returns for ex-US compared to US over the next decade, based largely upon valuations. A summary of opinions of many large firms

https://www.morningstar.com/articles/96 ... -forecasts

basically concurs.

Possibly the current market event will reset valuation data to some extent. We shall see.

Good luck!

xxd091
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Re: Is being in a world index fund true diversification?

Post by xxd091 » Sun Mar 01, 2020 5:23 am

If US goes down we are all stuffed so I wouldn’t worry about it too much
If really troubled buy gold and head for the hills!-take a gun!
I follow your thoughts -aged 73-retd 17 years-diversified many years ago
I also in addition use a Global Bond Index Tracker hedged to the Pound for my Bond allocation
Truly diversified-also 2 funds only-cheap,simple and easy to follow
I think you will see how good your choices are as this current downturn unfolds
I have been through 2001 and 2008 -your/mine Portfolio structure seems to work
Stay the course in the words of the great Jack Bogle!
xxd091

anil686
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Re: Is being in a world index fund true diversification?

Post by anil686 » Sun Mar 01, 2020 8:51 am

I would think so in general. One thing I think is often mis-stated or maybe understood but said in a weird way is how total world is market cap weighted by country (i.e. US is 55%). However, it is really *company* weighted, not country weighted. If you look at the top 100 holdings, 82% are US and 18% are ex-US and that makes up over 33% of the index. It becomes clear that large companies dominate the index so it is like a giant SP500 fund. The diversification present is the ability to capture the small segment of companies that may become world leaders that happen to be ex-US. For example, if the tech industry was not based in Silicon Valley, but was rather based in - for example - Germany, the US would not be as big a part of Total World, but the dynamism of the US economy/companies would not change in general. If you look at the past decade (since Great Recession), the biggest difference between TSM and TISM has been the FAANG stocks in general as well as currency movements. Outside of that, they have behaved fairly even meaning over time, if you believe there will be another sector (especially ex US heavy) that becomes a world leader, you would be poised to capture that. JMO though...

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Re: Is being in a world index fund true diversification?

Post by mega317 » Sun Mar 01, 2020 8:58 am

But again the same problem comes to me which is if in the next 20-30 years the US has terrible equity returns, but Europe does really well
The logical endpoint of your argument, albeit extreme, is what if the next 20-30 years the world has terrible equity returns but Amazon does really well.
You can't have a loss-proof stock portfolio nor can you guarantee you hold the best performing mix of stocks. All you can do is set your appropriate risk tolerance, minimize expenses, and hope for a good outcome. This is the point of diversification.
https://www.bogleheads.org/forum/viewtopic.php?t=6212

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asset_chaos
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Re: Is being in a world index fund true diversification?

Post by asset_chaos » Mon Mar 02, 2020 6:55 pm

The facile answer is that the distribution of market cap is what it is. Why do you think you know better than the market how capital should be distributed? There are an infinity of ways to sub-divide the stock market. Why are you preferencing a division of the market by geographic region? Instead of, say, industrial sector, factor loading, comparative risk, or any other way.

The other thing is that US market cap does not appear to be terribly out of line compared to its GDP, according to data from the World Bank plotted in the figure below and described in detail in this post.

Image

Data is from the end of 2017. Plotted horizontally is each country's fraction of world gross product (GDP); plotted vertically on a log scale is each country's fraction of world stock market capitalization (CAP). Note that CAP uses total market capitalization, not the free-float capitalization of stock market indices and index funds. The black line is a single parameter linear fit to all the data. The US is a little above that averaged line, but not grossly. On the other hand, China, Germany, and other emerging market countries are more noticeably below the average line. Except for Germany, maybe that's a collective decision by the market that stocks in those countries are riskier than average. I don't know.

Make of that what you will---and obviously you have a have a portfolio you're comfortable enough with to stick with through thick and thin---but it does not suggest to me that the market has obviously made the wrong risk-return collective decision in how to distribute capital around the globe.
Regards, | | Guy

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Re: Is being in a world index fund true diversification?

Post by asset_chaos » Mon Mar 02, 2020 7:05 pm

artfulinvestor83 wrote:
Sun Mar 01, 2020 4:05 am
I understand why the fund is market cap weighted per country, and the idea that you trust in an efficient market, and so as countries rise and fall their share within the fund will change.
That's not quite true. The global stock index funds I'm familiar with weight companies by market cap and the country weightings are mere byproducts. For example, the Vanguard total world fund follow a FTSE index. FTSE does not decide country weightings for the global all cap index. FTSE calculates the market cap of individual companies, then it includes the largest 8000 or so companies in proportion to their (the companies) market caps. This is done without regard to a company's domicile. The reporting of country weighting for the index is merely a byproduct of the company weighting. I.e. after deciding what's in the index FTSE then calculates that this fraction of the index consists of companies domiciled in France and that fraction of companies is domiciled in Mexico, etc.
Regards, | | Guy

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Re: Is being in a world index fund true diversification?

Post by JoMoney » Mon Mar 02, 2020 7:55 pm

artfulinvestor83 wrote:
Sun Mar 01, 2020 4:05 am
...
I know the consensus is that US stocks will have the best performance but no-one knows this...
Weird "consensus".
Everywhere I look I see people talking about how much "cheaper" international stocks are, with major investment houses giving capital market outlook outside the U.S. with higher expected returns.
But you're right when you say that nobody knows.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

chrismckay
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Re: Is being in a world index fund true diversification?

Post by chrismckay » Mon Mar 02, 2020 11:58 pm

I share your unease, and infact started a simalair thread not so long ago... viewtopic.php?f=22&t=288302&p=4700760#p4700760

Kinda "get it" now, kinda!!!!

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Re: Is being in a world index fund true diversification?

Post by Phineas J. Whoopee » Tue Mar 03, 2020 3:14 pm

Threads like this one pop up every few months, and inevitably descend into arguments over the definition of the word diversification.

Some posters have vehemently written that diversification means concentrating one's portfolio into certain types of stocks. I finally understood where they were coming from. It doesn't seem to me to be the right definition, but I am not the terminology dictator.

PJW

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Re: Is being in a world index fund true diversification?

Post by nisiprius » Tue Mar 03, 2020 3:35 pm

artfulinvestor83, the word "diversification" gets thrown around a lot, like "risk." The word has many different meanings. You need to start by deciding what you mean by "true" diversification and what you expect to get by it.

Just to take one example, the official definition of "diversified" in a mutual fund is (approximately) that the fund can do what it likes with 25% of its portfolio, but in the other 75% it mustn't put more than 5% into any single security, and it also must not own more than 10% of the outstanding shares of any security.

In the real world, many things have lopsided distributions. For example, in English, a quarter, 12% of English text consists of the single letter E; 1/8th, not 1/26th. In the competitive environment in which mutual funds operate, a few companies, notably Vanguard, have a commanding lead in cap-weighted index funds. Understandably, everyone else likes to attack cap-weighting, and many of the attacks are dishonest. If someone tried to convince you that there is something wrong with English being so concentrated in E, and tried to sell you some kind of software to help you compose English with fewer E's, you would not buy it. Be careful about facile arguments about the natural, market-based distribution of stock capitalization being wrong.
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Re: Is being in a world index fund true diversification?

Post by Valuethinker » Wed Mar 04, 2020 4:04 am

JoMoney wrote:
Mon Mar 02, 2020 7:55 pm
artfulinvestor83 wrote:
Sun Mar 01, 2020 4:05 am
...
I know the consensus is that US stocks will have the best performance but no-one knows this...
Weird "consensus".
Everywhere I look I see people talking about how much "cheaper" international stocks are, with major investment houses giving capital market outlook outside the U.S. with higher expected returns.
But you're right when you say that nobody knows.
When you adjust for the very different index compositions (basically the US has almost all the world's leading tech stocks except Samsung, TSMC, ASML and a few others) then the differences in index valuation are much smaller.

The other factor is that post Crash, US financials have performed much better especially v. European financials.

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Re: Is being in a world index fund true diversification?

Post by GRP » Wed Mar 04, 2020 4:56 am

Not really.

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Re: Is being in a world index fund true diversification?

Post by artfulinvestor83 » Thu Mar 05, 2020 2:39 am

Hi all,

Thank you for all the replies.

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Re: Is being in a world index fund true diversification?

Post by artfulinvestor83 » Thu Mar 05, 2020 3:58 am

nisiprius wrote:
Tue Mar 03, 2020 3:35 pm
artfulinvestor83, the word "diversification" gets thrown around a lot, like "risk." The word has many different meanings. You need to start by deciding what you mean by "true" diversification and what you expect to get by it.

Just to take one example, the official definition of "diversified" in a mutual fund is (approximately) that the fund can do what it likes with 25% of its portfolio, but in the other 75% it mustn't put more than 5% into any single security, and it also must not own more than 10% of the outstanding shares of any security.

In the real world, many things have lopsided distributions. For example, in English, a quarter, 12% of English text consists of the single letter E; 1/8th, not 1/26th. In the competitive environment in which mutual funds operate, a few companies, notably Vanguard, have a commanding lead in cap-weighted index funds. Understandably, everyone else likes to attack cap-weighting, and many of the attacks are dishonest. If someone tried to convince you that there is something wrong with English being so concentrated in E, and tried to sell you some kind of software to help you compose English with fewer E's, you would not buy it. Be careful about facile arguments about the natural, market-based distribution of stock capitalization being wrong.
Thanks for your reply.

To me the aim of diversification is to reduce risk, and I want to diversify in three ways:

1) Between asset classes - my portfolio has equities, government bonds, gold and REITs.
2) Over time - I invest a certain amount to my portfolio every other month for the next 20-30 years
3) Geographically - being global

It's 3) which I'm still struggling with. I don't think your analogy with the English language above works very well to be honest, because the fact that the English language uses more of the letter E than other letters is a feature of the language and the way we use it, and it's probably been true for hundreds of years with little fluctuation. In comparison, US equities forming such a large weighted cap of the entire market has not been true for hundreds of years, and might not be the case in 20-30 years time, and more importantly, as an investor we wants returns, and the best performing equity markets (highest returns) each decade have not been the US in the last 100 years.

For example, if we take 13 countries (Sweden, Korea, Japan, Spain, Germany, UK, Italy, France, Switzerland, US, Australia, Norway, Canada) and look at their individual stock market returns over the decades and compare the highest returning stock market, versus what it would have been if we had equally weighted our portfolio per country (NOT by market weighted cap of the equities in all these countries) versus the US stock market return we would get the following (figures in excess returns above cash):

2010's - (Best performing US 182%) vs (equal weighted portfolio 74%)
2000's - (Best performing Norway 48%) vs (equal weighted 1%) vs (US -27%)
1990's - (Best performing Switzerland 231%) vs (equal weighted 53%) vs (US 217%)
1980's - (Best performing Sweden 503%) vs (equal weighted 185%) vs (US 96%)
1970's - (Best performing Korea 456%) vs (equal weighted 10%) vs (US -17%)
1960's - (Best performing Spain 312%) vs (equal weighted 75%) vs (US 41%)

I got these figures from this article by Bridgewater:

https://www.bridgewater.com/research-li ... lifesaver/

So what am I saying? My thinking goes that by using a world index fund of equities which is market cap weighted, it takes on the the inherit bias of size and recent performance. Within our portfolios we have our asset allocation, of say 80% equities, 20% bonds. When this gets out of whack because of recent performance and say equities do really well, then say after a year the portfolio has morphed to 87% stocks and 13% bonds, we don't just say this is what the market has decided, instead we say we must rebalance, and we know that if we rebalance once a year or so, it will actually increase our returns because we are selling high and buying low. So within the asset class of equities, shouldn't we rebalance when one area does really well, such as the US in the 2010's, because we know based on historic data this is unlikely to continue. If the majority of my equities are US based companies within US indices then I won't capture enough gains from the country which will do best this decade and the decade after.

I really appreciate your thoughts and critique of the above thinking. Please continue if you'd be willing. I'm not trying to prove a point or stick to my thinking, and indeed the current part of my equity portfolio is in a world index fund as I want to be 100% sure of the above before I make any changes to it.

If the above rational does hold up though, then I would want to change the equity part of my portfolio to have a bit more weighting to other countries. It won't be equally weighted because that would be so hard to do with the products available, but it would be more balanced geographically than currently and perhaps the US part only 20-25% instead of being 55-65%.

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Re: Is being in a world index fund true diversification?

Post by BeBH65 » Thu Mar 05, 2020 4:50 am

artfulinvestor83 wrote:
Thu Mar 05, 2020 3:58 am
To me the aim of diversification is to reduce risk, and I want to diversify in three ways:

[...]
3) Geographically - being global

It's 3) which I'm still struggling with.
[...]

2010's - (Best performing US 182%) vs (equal weighted portfolio 74%)
2000's - (Best performing Norway 48%) vs (equal weighted 1%) vs (US -27%)
1990's - (Best performing Switzerland 231%) vs (equal weighted 53%) vs (US 217%)
1980's - (Best performing Sweden 503%) vs (equal weighted 185%) vs (US 96%)
1970's - (Best performing Korea 456%) vs (equal weighted 10%) vs (US -17%)
1960's - (Best performing Spain 312%) vs (equal weighted 75%) vs (US 41%)
If you use diversification to reduce risk, I guess you should first look at the worst performing countries.
The risk is that if you would only have invested in that country you would only have had the return of that worse country.
With diversification you will not have the performance of the worst country, you will have an average performance.
BeBH65. (only an investment enthusiast, not a financial adviser, perform your due diligence). | Have a look at https://www.bogleheads.org/wiki/Outline_of_Non-US_domiciles

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Re: Is being in a world index fund true diversification?

Post by artfulinvestor83 » Thu Mar 05, 2020 5:26 am

BeBH65 wrote:
Thu Mar 05, 2020 4:50 am
artfulinvestor83 wrote:
Thu Mar 05, 2020 3:58 am
To me the aim of diversification is to reduce risk, and I want to diversify in three ways:

[...]
3) Geographically - being global

It's 3) which I'm still struggling with.
[...]

2010's - (Best performing US 182%) vs (equal weighted portfolio 74%)
2000's - (Best performing Norway 48%) vs (equal weighted 1%) vs (US -27%)
1990's - (Best performing Switzerland 231%) vs (equal weighted 53%) vs (US 217%)
1980's - (Best performing Sweden 503%) vs (equal weighted 185%) vs (US 96%)
1970's - (Best performing Korea 456%) vs (equal weighted 10%) vs (US -17%)
1960's - (Best performing Spain 312%) vs (equal weighted 75%) vs (US 41%)
If you use diversification to reduce risk, I guess you should first look at the worst performing countries.
The risk is that if you would only have invested in that country you would only have had the return of that worse country.
With diversification you will not have the performance of the worst country, you will have an average performance.
If you are weighted equally-ish between stock markets in different countries I think you are then diversified globally. With a world index fund you're 55%-65% US equities vs 5% UK or 2-3% Germany or 7% Japan - so you're not anywhere near equal-ish. In sum 55-65% US equities versus 35%-45% rest of the world. Half my egg is in the US market which we see from the data above from the last 60 years was only the best performer during a whole decade once!
Last edited by artfulinvestor83 on Thu Mar 05, 2020 6:10 am, edited 1 time in total.

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Re: Is being in a world index fund true diversification?

Post by andrew99999 » Thu Mar 05, 2020 5:57 am

BeBH65 wrote:
Thu Mar 05, 2020 4:50 am
With diversification you will not have the performance of the worst country, you will have an average performance.
I'm not following your logic here.

Are you saying that when you compare it to the worst, the US hasn't been the absolute worst so therefore you're diversified by having the majority of your money in the US?

If that's not your point, what's the point of comparing the US to the worst performer?

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Re: Is being in a world index fund true diversification?

Post by JimBeam » Thu Mar 05, 2020 6:24 am

artfulinvestor83 wrote:
Thu Mar 05, 2020 5:26 am
If you are weighted equally-ish between stock markets in different countries I think you are then diversified globally. With a world index fund you're 55%-65% US equities vs 5% UK or 2-3% Germany or 7% Japan - so you're not anywhere near equal-ish. In sum 55-65% US equities versus 35%-45% rest of the world. Half my egg is in the US market which we see from the data above from the last 60 years was only the best performer during a whole decade once!
Please remember that "55%-65% US equities" doesn't mean, that these equities are US-only companies, selling products only in USA. Alibaba is listed on NYSE, but it's not a US company. Many companies listed on US stock exchanges sell their products and services world-wide.
I'd just stick with global indexes like MSCI ACWI or FTSE All-World and appreciate the fact, that we can invest in ETF's or mutual funds based on them.

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Re: Is being in a world index fund true diversification?

Post by BeBH65 » Thu Mar 05, 2020 10:00 am

andrew99999 wrote:
Thu Mar 05, 2020 5:57 am
BeBH65 wrote:
Thu Mar 05, 2020 4:50 am
With diversification you will not have the performance of the worst country, you will have an average performance.
I'm not following your logic here.

Are you saying that when you compare it to the worst, the US hasn't been the absolute worst so therefore you're diversified by having the majority of your money in the US?

If that's not your point, what's the point of comparing the US to the worst performer?
The point that I tried to make is:
If one invests worldwide then one will never have the worst performance.
If one only invest in one country one has the risk that the chosen country will be worst performer: look at Japan.
BeBH65. (only an investment enthusiast, not a financial adviser, perform your due diligence). | Have a look at https://www.bogleheads.org/wiki/Outline_of_Non-US_domiciles

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Re: Is being in a world index fund true diversification?

Post by retiredjg » Thu Mar 05, 2020 10:06 am

artfulinvestor83 wrote:
Sun Mar 01, 2020 4:05 am
25% US equity
25% European Developed
25% Asia Pacific Developed inc Japan
25% Emerging markets
To me, this is an artificially based allocation because it is not based on anything that actually exists. It is symetrical...which is meaningless. It overweights the developed and Pacific markets and grossly overweights the emerging markets. These things increase the risk of your portfolio.

What's the logic behind that?

Is being in a world index fund true diversification?
Yes.

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Re: Is being in a world index fund true diversification?

Post by artfulinvestor83 » Thu Mar 05, 2020 3:11 pm

retiredjg wrote:
Thu Mar 05, 2020 10:06 am
artfulinvestor83 wrote:
Sun Mar 01, 2020 4:05 am
25% US equity
25% European Developed
25% Asia Pacific Developed inc Japan
25% Emerging markets
To me, this is an artificially based allocation because it is not based on anything that actually exists. It is symetrical...which is meaningless. It overweights the developed and Pacific markets and grossly overweights the emerging markets. These things increase the risk of your portfolio.

What's the logic behind that?

Is being in a world index fund true diversification?
Yes.
It was my rough attempt at more equally weighting equities by countries. I would actually change the above even more so that exposure to one country is roughly capped at 10% (and have changed my original post above to reflect this). I explained the logic in a follow-up post a few comments above this one.

I'm not sure I understand the bit about it being based on nothing that exists. In a classical 60/40 portfolio what is this based on? All the stock markets of the world add up to roughly $18.5 trillion, and the total global bond market is estimated at $100 trillion. Should our asset allocation therefore be 20% bonds vs 80% stocks. No of course not. We vary our asset class proportions based on the returns and risks we are comfortable with in the portfolio. Should we not then do the same within an asset class so that our returns are not dependant on one country only?

Please note I'm not trying to be argumentative at all. I really would like to see how my thinking is wrong so that I can invest better for retirement.
Last edited by artfulinvestor83 on Thu Mar 05, 2020 3:24 pm, edited 1 time in total.

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Re: Is being in a world index fund true diversification?

Post by watchnerd » Thu Mar 05, 2020 3:21 pm

artfulinvestor83 wrote:
Sun Mar 01, 2020 4:05 am
I know the consensus is that US stocks will have the best performance but no-one knows this.
It's actually not the consensus in the 2020 outlook papers from Vanguard, JP Morgan, and Blackrock.

All 3 of those expect the US to underperform --- over the next decade. We can check back in 10 years.

I own world market cap in equities, so I don't have to guess who the winner will be.
70% Global Market Weight Equities | 15% Long Treasuries 15% short TIPS & cash || RSU + ESPP

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Re: Is being in a world index fund true diversification?

Post by watchnerd » Thu Mar 05, 2020 3:26 pm

artfulinvestor83 wrote:
Sun Mar 01, 2020 4:05 am

This is true diversification because I'm saying I don't know which region will have the best performance going forward so I want equal exposure to all of them.
This is a reasonable point of view, and one I follow.

But don't try to reverse engineer the weightings. Just pick a fund like VT/VTWAX and you get market weight automatically.

Equal weighting is not intellectually consistent with avoiding guessing.

Equal weighting = over weighting / underweighting = guessing which region does better.
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Re: Is being in a world index fund true diversification?

Post by artfulinvestor83 » Thu Mar 05, 2020 3:43 pm

watchnerd wrote:
Thu Mar 05, 2020 3:26 pm
artfulinvestor83 wrote:
Sun Mar 01, 2020 4:05 am

This is true diversification because I'm saying I don't know which region will have the best performance going forward so I want equal exposure to all of them.
This is a reasonable point of view, and one I follow.

But don't try to reverse engineer the weightings. Just pick a fund like VT/VTWAX and you get market weight automatically.

Equal weighting is not intellectually consistent with avoiding guessing.

Equal weighting = over weighting / underweighting = guessing which region does better.
Thank you. So we agree that we want global diversification of equities because we don't know which equity markets will be best performing going forward. However with a market weighted world equity index fund isn't the return of the fund overwhemingly dependent on the return of the highest component of the fund e.g US equities. If in the next decade US equities do poorly with negative returns (as they did in the 2000's and 1970's), but China and India do great, my world index fund will do poorly because currently China has a weight of around 3.7% and India less than 2%. The gains they make won't make up for the losses in the US share (55%-65%) because they are such a small portion of my portfolio. But if the equity part of my portfolio started with 10% US, 10% India, 10% China, I will do well if the US tanks and China and India do well. Wouldn't it make sense therefore to arrange the equity part of my portfolio so a selection of countries both developed and emerging account of 5-10% each?

This is the argument I can't seem to resolve or get away from.

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Re: Is being in a world index fund true diversification?

Post by watchnerd » Thu Mar 05, 2020 3:55 pm

artfulinvestor83 wrote:
Thu Mar 05, 2020 3:43 pm

Thank you. So we agree that we want global diversification of equities because we don't know which equity markets will be best performing going forward.
I agree with this.
artfulinvestor83 wrote:
Thu Mar 05, 2020 3:43 pm
Wouldn't it make sense therefore to arrange the equity part of my portfolio so a selection of countries both developed and emerging account of 5-10% each?
That's not consistent with "we don't know".

You're saying you're better at guessing the future than the collective wisdom of the market.

By moving away from market weights, you're making a bet, as opposed to taking whatever the global market gives you.
Last edited by watchnerd on Thu Mar 05, 2020 4:09 pm, edited 1 time in total.
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Re: Is being in a world index fund true diversification?

Post by mega317 » Thu Mar 05, 2020 3:58 pm

artfulinvestor83 wrote:
Thu Mar 05, 2020 3:43 pm
If in the next decade US equities do poorly with negative returns (as they did in the 2000's and 1970's), but China and India do great, my world index fund will do poorly because currently China has a weight of around 3.7% and India less than 2%. The gains they make won't make up for the losses in the US share (55%-65%) because they are such a small portion of my portfolio. But if the equity part of my portfolio started with 10% US, 10% India, 10% China, I will do well if the US tanks and China and India do well. Wouldn't it make sense therefore to arrange the equity part of my portfolio so a selection of countries both developed and emerging account of 5-10% each?

This is the argument I can't seem to resolve or get away from.
You can construct an infinite number of ifs. If China and India don't "do great" then your plan fails.
artfulinvestor83 wrote:
Thu Mar 05, 2020 3:11 pm
I'm not sure I understand the bit about it being based on nothing that exists. In a classical 60/40 portfolio what is this based on? All the stock markets of the world add up to roughly $18.5 trillion, and the total global bond market is estimated at $100 trillion. Should our asset allocation therefore be 20% bonds vs 80% stocks. No of course not.
Adjusting stock/bond ratio is a purposeful way of adjusting your risk. Your arbitrary weights to different countries/regions appears to be a less purposeful way of adjusting risk.
https://www.bogleheads.org/forum/viewtopic.php?t=6212

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Re: Is being in a world index fund true diversification?

Post by artfulinvestor83 » Thu Mar 05, 2020 4:10 pm

mega317 wrote:
Thu Mar 05, 2020 3:58 pm

You can construct an infinite number of ifs. If China and India don't "do great" then your plan fails.
That doesn't make sense. You're highlighting the fact that we don't know. If like you say India and China don't do great in this imaginary 3 country equally weighted fund, then the entire fund wouldn't do well, but can you imagine if both countries didn't do well and one of them accounted for 55-65% of the fund. Therefore isn't the lesson don't be concentrated in one country?
Last edited by artfulinvestor83 on Thu Mar 05, 2020 4:13 pm, edited 1 time in total.

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Re: Is being in a world index fund true diversification?

Post by watchnerd » Thu Mar 05, 2020 4:13 pm

artfulinvestor83 wrote:
Thu Mar 05, 2020 4:10 pm

If they both didn't do great then my overall imaginary fund of 3 countries wouldn't do well, but it would do better than if 55-65% was composed of either India or China. So spread the risk no?
I think you're missing a key concept...

Once you own the whole global market, you don't care how individual countries do.

I don't care if India beats USA, or Brazil trumps everyone over the next 20 years.

I care how the collection of everybody together does, in aggregate.
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Re: Is being in a world index fund true diversification?

Post by artfulinvestor83 » Thu Mar 05, 2020 4:17 pm

watchnerd wrote:
Thu Mar 05, 2020 4:13 pm
artfulinvestor83 wrote:
Thu Mar 05, 2020 4:10 pm

If they both didn't do great then my overall imaginary fund of 3 countries wouldn't do well, but it would do better than if 55-65% was composed of either India or China. So spread the risk no?
I think you're missing a key concept...

Once you own the whole global market, you don't care how individual countries do.

I don't care if India beats USA, or Brazil trumps everyone over the next 20 years.

I care how the collection of everybody together does, in aggregate.
No I agree with that concept. I don't want to care which country does well because I can't predict it. But in order to fully realise the benefits of the countries that do well, surely they have to be more equally weighted. Coming back to what I said, if China does very well in the next 10 years, followed by India for 10 years, but the US doesn't do well over the 20 years, because my fund started with such a low weight for China (3.7%) and India (less than 2%) I won't realise enough gains from them to make up for the large concentration of US equities (55-65%) that does badly.

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Re: Is being in a world index fund true diversification?

Post by watchnerd » Thu Mar 05, 2020 4:36 pm

artfulinvestor83 wrote:
Thu Mar 05, 2020 4:17 pm
No I agree with that concept. I don't want to care which country does well because I can't predict it. But in order to fully realise the benefits of the countries that do well, surely they have to be more equally weighted. Coming back to what I said, if China does very well in the next 10 years, followed by India for 10 years, but the US doesn't do well over the 20 years, because my fund started with such a low weight for China (3.7%) and India (less than 2%) I won't realise enough gains from them to make up for the large concentration of US equities (55-65%) that does badly.
You're not investing in countries.

You're investing in companies that happen to be domiciled in different nations.

Investing in Roche is not a bet on Switzerland, as a nation.

Investing in Virgin Galactic is not a bet on the UK, as a nation.

etc.

The countries don't matter at all.
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Re: Is being in a world index fund true diversification?

Post by watchnerd » Thu Mar 05, 2020 4:41 pm

Perhaps this video will help:

https://www.youtube.com/watch?v=LwTHLtuToSY
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Re: Is being in a world index fund true diversification?

Post by vineviz » Thu Mar 05, 2020 4:43 pm

watchnerd wrote:
Thu Mar 05, 2020 4:36 pm
The countries don't matter at all.
There's a grain of truth in the point I expect you are trying to make, but this statement is definitively not true.

Country of domicile and the location of the listing exchange both explain a significant portion of a stock's return, above and beyond other factors (industry, regional revenue exposure, size, etc.).
"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: Is being in a world index fund true diversification?

Post by watchnerd » Thu Mar 05, 2020 4:45 pm

vineviz wrote:
Thu Mar 05, 2020 4:43 pm
watchnerd wrote:
Thu Mar 05, 2020 4:36 pm
The countries don't matter at all.
There's a grain of truth in the point I expect you are trying to make, but this statement is definitively not true.

Country of domicile and the location of the listing exchange both explain a significant portion of a stock's return, above and beyond other factors (industry, regional revenue exposure, size, etc.).
I put that in the category of "everything matters".

And I don't consider those cultural / financial / regulatory elements to be sufficient for me to overweight any particular nation.

As a decision criteria, it doesn't matter to me.
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Re: Is being in a world index fund true diversification?

Post by vineviz » Thu Mar 05, 2020 4:50 pm

watchnerd wrote:
Thu Mar 05, 2020 4:45 pm
vineviz wrote:
Thu Mar 05, 2020 4:43 pm
watchnerd wrote:
Thu Mar 05, 2020 4:36 pm
The countries don't matter at all.
There's a grain of truth in the point I expect you are trying to make, but this statement is definitively not true.

Country of domicile and the location of the listing exchange both explain a significant portion of a stock's return, above and beyond other factors (industry, regional revenue exposure, size, etc.).
I put that in the category of "everything matters".

And I don't consider those cultural / financial / regulatory elements to be sufficient for me to overweight any particular nation.
That's fine with me, though in all fairness what you're calling "overweight" I'd probably call "appropriate-weight": over- or underweight is a subjective evaluation in the end.

Anyway, I'm just pointing out that the "country doesn't matter" argument isn't supported by the reality of how stocks get priced.
"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: Is being in a world index fund true diversification?

Post by watchnerd » Thu Mar 05, 2020 4:53 pm

vineviz wrote:
Thu Mar 05, 2020 4:50 pm


Anyway, I'm just pointing out that the "country doesn't matter" argument isn't supported by the reality of how stocks get priced.
I get what you're saying -- but for a confused person not understanding how global market weights work, getting into the minutiae of how stock factors vary by the particular listing exchange is probably more confusing than it is clarifying.
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Re: Is being in a world index fund true diversification?

Post by vineviz » Thu Mar 05, 2020 5:23 pm

watchnerd wrote:
Thu Mar 05, 2020 4:53 pm
vineviz wrote:
Thu Mar 05, 2020 4:50 pm


Anyway, I'm just pointing out that the "country doesn't matter" argument isn't supported by the reality of how stocks get priced.
I get what you're saying -- but for a confused person not understanding how global market weights work, getting into the minutiae of how stock factors vary by the particular listing exchange is probably more confusing than it is clarifying.
I agree. My view is that the default recommendation for someone who has zero interest in the minutiae of investing is to use a global market cap weighted fund (as referenced in the OP) and call it "good enough".
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Re: Is being in a world index fund true diversification?

Post by watchnerd » Thu Mar 05, 2020 5:44 pm

vineviz wrote:
Thu Mar 05, 2020 5:23 pm
watchnerd wrote:
Thu Mar 05, 2020 4:53 pm
vineviz wrote:
Thu Mar 05, 2020 4:50 pm


Anyway, I'm just pointing out that the "country doesn't matter" argument isn't supported by the reality of how stocks get priced.
I get what you're saying -- but for a confused person not understanding how global market weights work, getting into the minutiae of how stock factors vary by the particular listing exchange is probably more confusing than it is clarifying.
I agree. My view is that the default recommendation for someone who has zero interest in the minutiae of investing is to use a global market cap weighted fund (as referenced in the OP) and call it "good enough".
+1

(heck, I enjoy the minutiae of playing with factors in my "play account", but I still use the global market weight funds for my real port)
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Re: Is being in a world index fund true diversification?

Post by Phineas J. Whoopee » Thu Mar 05, 2020 5:46 pm

OP: Thank you for explaining that by the word diversified you mean equal weight. That's far from the only definition.

Taken to its logical conclusion equal weight, within listed equities, is an equal weight for each publicly traded corporation. If your geographically-based weights are a proxy for that then you're being internally consistent.

I don't agree with equal weighting, but of course investors should be able to pursue it as an option if they see fit, using their own resources.

Some allocations will return more than market-cap based, and some will return less, over any measured period of time. We just don't know which ones, in advance.

PJW

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Re: Is being in a world index fund true diversification?

Post by watchnerd » Thu Mar 05, 2020 5:48 pm

Phineas J. Whoopee wrote:
Thu Mar 05, 2020 5:46 pm
OP: Thank you for explaining that by the word diversified you mean equal weight. That's far from the only definition.

Taken to its logical conclusion equal weight, within listed equities, is an equal weight for each publicly traded corporation. If your geographically-based weights are a proxy for that then you're being internally consistent.

I don't agree with equal weighting, but of course investors should be able to pursue it as an option if they see fit, using their own resources.

Some allocations will return more than market-cap based, and some will return less, over any measured period of time. We just don't know which ones, in advance.

PJW
One question to equal weight would be -- equal weight by what?

By stock (as mentioned above)?

Equal percentage to every country in the indices?

Normalized by population?

By GDP?
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Re: Is being in a world index fund true diversification?

Post by Call_Me_Op » Thu Mar 05, 2020 5:50 pm

artfulinvestor83 wrote:
Sun Mar 01, 2020 4:05 am
So therefore am I truly diversified?
Define "diversified," and I can easily answer you.
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Re: Is being in a world index fund true diversification?

Post by Phineas J. Whoopee » Thu Mar 05, 2020 6:05 pm

watchnerd wrote:
Thu Mar 05, 2020 5:48 pm
Phineas J. Whoopee wrote:
Thu Mar 05, 2020 5:46 pm
OP: Thank you for explaining that by the word diversified you mean equal weight. That's far from the only definition.

Taken to its logical conclusion equal weight, within listed equities, is an equal weight for each publicly traded corporation. If your geographically-based weights are a proxy for that then you're being internally consistent.

I don't agree with equal weighting, but of course investors should be able to pursue it as an option if they see fit, using their own resources.

Some allocations will return more than market-cap based, and some will return less, over any measured period of time. We just don't know which ones, in advance.

PJW
One question to equal weight would be -- equal weight by what?

By stock (as mentioned above)?

Equal percentage to every country in the indices?

Normalized by population?

By GDP?
Equal weight by stock, by GDP, by national boundaries all can be equal weight. Some high-GDP, especially GDP per capita, countries may have very little in terms of listed stocks.

I was expanding on OP's definition done geographically.

Equal weight by total value of assets in the country can be equal weight, or by state or province or county or other municipality.

What do you mean by equal weight? What do you mean by diversification? There's your answer.

PJW

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Re: Is being in a world index fund true diversification?

Post by andrew99999 » Thu Mar 05, 2020 10:15 pm

watchnerd wrote:
Thu Mar 05, 2020 4:13 pm
Once you own the whole global market, you don't care how individual countries do.
If I have 60% of my equities in one country, then i sure as hell do care how that individuals country does.
Cap weighting doesn't alleviate this.
Yes it alleviates the fact that I don't know more than the market, but it sure doesn't alleviate the fact that you now face single country risk with a huge amount of your portfolio.
watchnerd wrote:
Thu Mar 05, 2020 4:36 pm
You're not investing in countries.

You're investing in companies that happen to be domiciled in different nations.

Investing in Roche is not a bet on Switzerland, as a nation.

Investing in Virgin Galactic is not a bet on the UK, as a nation.

etc.

The countries don't matter at all.
All the information that goes on is priced in to companies. One of those pieces of information is regarding the country it is in, so yes it definitely does matter.
watchnerd wrote:
Thu Mar 05, 2020 4:53 pm
I get what you're saying -- but for a confused person not understanding how global market weights work, getting into the minutiae of how stock factors vary by the particular listing exchange is probably more confusing than it is clarifying.
I think OP has a valid point. I also think that cap weighting as a way of saying you don't know more than the market is a valid point. I don't really know if there is a solution that covers both points but I think you're being dismissive saying it is a confused person.

I also think that PJW is arguing semantics by asking what "diversification" means when we could just say that there is an overweight of single country risk. This has been partly addressed by the fact that many companies are international companies, but the issue remains that all of these companies are still affected by politics and laws of that single country it is based in, which are all priced into those companies.

I don't have a better solution than cap weighting, but I also don't think this issue is something you can just dismiss as saying anyone pointing it is confused. I think it's a valid point.

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Re: Is being in a world index fund true diversification?

Post by watchnerd » Thu Mar 05, 2020 10:28 pm

andrew99999 wrote:
Thu Mar 05, 2020 10:15 pm


I think OP has a valid point. I also think that cap weighting as a way of saying you don't know more than the market is a valid point. I don't really know if there is a solution that covers both points but I think you're being dismissive saying it is a confused person.
I don't think it's possible to cover both points.

They're diametrically opposed, to a great degree.

Either:

1. The Market Is Wise -- Millions of actors invest with their wallets. Follow the money. Use cap-weighting.

2. The Market Is Unwise -- Humans are irrational. Following the money is just joining a herd of blind sheep. Use something else.

The challenge with #2 is....what is the better "something else"?
Last edited by watchnerd on Thu Mar 05, 2020 11:36 pm, edited 1 time in total.
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Re: Is being in a world index fund true diversification?

Post by andrew99999 » Thu Mar 05, 2020 11:04 pm

watchnerd wrote:
Thu Mar 05, 2020 10:28 pm
The challenge with #2 is....what is the a better "something else"?
Agreed. Cap weighting is a bit like democracy - it's far from perfect but alternatives have been worse (sometimes horrendously).

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Re: Is being in a world index fund true diversification?

Post by glorat » Thu Mar 05, 2020 11:37 pm

watchnerd wrote:
Thu Mar 05, 2020 10:28 pm
I don't think it's possible to cover both points.

They're diametrically opposed, to a great degree.

Either:

1. The Market Is Wise -- Millions of actors invest with their wallets. Follow the money. Use cap-weighting.

2. The Market Is Unwise -- Humans are irrational. Following the money is just joining a herd of blind sheep. Use something else.

The challenge with #2 is....what is the a better "something else"?
I'll bite and try to cover both!

I shall claim that most investors believe in 2. The only solution is to prove it by finding one of the many strategies to beat the market.

And of course conviction now runs into emperical reality that most people fail perhaps due to costs so Bogleheads give up on beating the market and go with 1.

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Re: Is being in a world index fund true diversification?

Post by artfulinvestor83 » Fri Mar 06, 2020 3:33 am

watchnerd wrote:
Thu Mar 05, 2020 4:36 pm

You're not investing in countries.

You're investing in companies that happen to be domiciled in different nations.

Investing in Roche is not a bet on Switzerland, as a nation.

Investing in Virgin Galactic is not a bet on the UK, as a nation.

etc.

The countries don't matter at all.
Not as simple as you make it out to be. Many factors within a country e.g. government policies, demographics, stage of economic cycle they are in, etc. will significantly affect the expected returns of companies in those countries and thus the price of their stock. Look what would have happened to the the share price of UK companies if Jeremy Corbyn would have been elected.

Some companies will be highly dependant on this and others less so because they are more 'global' and have sales in other countries or complex supply chains or more exposed to the global economy etc.

It's complicated and I don't know the size of the correlations.

How much does the US economy affect global stock markets? The bursting of the US housing market in 2007 helped cause a global financial crisis.

Sometimes (though not often) the stock market of an entire country can disappear - look at the German and Russian stock market in the beginning of the last century.

Finally when a company like Vanguard creates a world index fund, what is their process? My understanding is that they look at the rough percentage share of the size of each countries stock market compared to the global market and then invest in a range of companies in that country to represent roughly the entire stock market of that country in the proportion they allocate (can vary between large, mid, small cap based on the fund). They don't just invest in the top 6000 companies in the world by market cap. I could be wrong about this, but if I'm not then your statement that "You're not investing in companies. You're investing in companies that happen to be domiciled in different countries." is not accurate.

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Re: Is being in a world index fund true diversification?

Post by artfulinvestor83 » Fri Mar 06, 2020 3:44 am

glorat wrote:
Thu Mar 05, 2020 11:37 pm
watchnerd wrote:
Thu Mar 05, 2020 10:28 pm
I don't think it's possible to cover both points.

They're diametrically opposed, to a great degree.

Either:

1. The Market Is Wise -- Millions of actors invest with their wallets. Follow the money. Use cap-weighting.

2. The Market Is Unwise -- Humans are irrational. Following the money is just joining a herd of blind sheep. Use something else.

The challenge with #2 is....what is the a better "something else"?
I'll bite and try to cover both!

I shall claim that most investors believe in 2. The only solution is to prove it by finding one of the many strategies to beat the market.

And of course conviction now runs into emperical reality that most people fail perhaps due to costs so Bogleheads give up on beating the market and go with 1.
It's not one or the other. Isn't it often both? The markets gain or lose value in one area based on new information about the future, but they tend to overreact based on fear and greed or irrational exuberance. I'm currently reading a book by the same name, Irrational Exuberance by Robert Schiller.

Sometimes markets are wise and sometimes they are not. But this does not mean that we have to attempt to beat the market as hardly anyone has shown they can consistently do that.

So I'm with you. Low fees, tax efficient, passive investing, index funds, stay the course.

My only concern is concentration of risk and with a world index fund the way they are set up by market cap weight, the equity part of my portfolio is highly concentrated on the performance of US companies and the US economy, because though many of their companies are 'global' some estimates show that the entire US stock market, let alone the S&P 500, is overwhelmingly dependant on revenues from US consumers.
Last edited by artfulinvestor83 on Fri Mar 06, 2020 3:52 am, edited 1 time in total.

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Re: Is being in a world index fund true diversification?

Post by JimBeam » Fri Mar 06, 2020 3:50 am

artfulinvestor83 wrote:
Fri Mar 06, 2020 3:33 am
They don't just invest in the top 6000 companies in the world by market cap.
They do, however not in top 6000, but in top 3400. If the company is big enough and listed on any stock exchange, it will make it's way into Russell's FTSE All-World Index and then Vanguard fund, tracking this index, will buy this company's shares.

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Re: Is being in a world index fund true diversification?

Post by halfnine » Fri Mar 06, 2020 4:50 am

OP, I invest globally with the qualification of capping my exposure to any individual country's market to 40%. I am happy with that compromise.

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