Portfolio Diversification, Long Before Mr. Markowitz

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SimpleGift
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Portfolio Diversification, Long Before Mr. Markowitz

Post by SimpleGift » Sat Jun 23, 2018 6:24 pm

In researching the deep history of global stock and bond returns (discussed here), I wanted to share some interesting historical tidbits about portfolio diversification in the late 1800s and early 1900s, primarily from the United Kingdom. The U.K. certainly had the largest and most diverse security markets in the world at the time, and basic portfolio diversification concepts were already being developed, long before Harry Markowitz's statement of Modern Portfolio Theory in the 1950s.

Previously, in the 1700s, portfolio diversification was apparently nonexistent, as investors usually stuck with just one company, possibly due to financial illiteracy or to restrictive company rules on shareholders. But by the 1870s, the market portfolio available in the United Kingdom contained a diverse selection of stocks and bonds, both foreign and domestic (chart below) — and some of the earliest advice on financial portfolio diversification had already started circulating.
Thirty years later in 1903, the U.K market portfolio was dominated by foreign stocks and bonds (chart below), including investments in the dominions and colonies, plus a diverse selection of securities from U.S. railroads, to Australian mines, to Argentinian ranches, etc. Also at this time, detailed advice on international stock diversification was first being published.
It was a bit surprising to discover that the concepts of financial risk sharing and international diversification were already well known and formalized, long before Mr. Markowitz developed MPT using mean-variance optimization in the 1950s.

Your thoughts?
Last edited by SimpleGift on Sat Jun 23, 2018 11:28 pm, edited 1 time in total.
Cordially, Todd

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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by pragmatist » Sat Jun 23, 2018 6:54 pm

"The owl of Minerva takes its flight only when the shades of night are gathering." G.W.F. Hegel

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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by Random Walker » Sat Jun 23, 2018 6:58 pm

"Let every man divide his money into three parts, and invest a third in land, a third in business and a third let him keep by him in reserve."

Talmud, circa 1200 B.C

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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by SimpleGift » Sat Jun 23, 2018 7:05 pm

Just to add: In his 1906 book, Investment: An Exact Science, Henry Lowenfeld recommends that investors divide their capital between the various continents and economic zones of the world (table below). His reasoning is fairly specific about distributing portfolio risk internationally:
Henry Lowenfeld in 1906 wrote:"As the trade prosperity of each country differs from that of all other countries, so the price movements of the stocks in each country differ from those of all other countries.

Thus if an investor divides his capital equally among a number of stocks every one of which is under a different trade influence, then each of these divisions of his capital will constitute a distinct investment risk, and a true system of averaging investment risks is thereby established."
  • Image
    Note: The table is truncated on the right, from a copy.
    Source: Lowenfeld, 1906.
Mr. Lowenfeld's advice still seems sound over 100 years later — though the diversification benefits may be a bit less today.
Cordially, Todd

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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by heyyou » Sat Jun 23, 2018 7:27 pm

With my confirmation bias, I'm glad to see the history.

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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by Rick Ferri » Sat Jun 23, 2018 7:37 pm

While it is true that basic investment principles go back thousands of years, the PhDs put math behind the theories to first prove or disprove them, and second to refine them. That’s their contribution.
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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by nisiprius » Sat Jun 23, 2018 8:08 pm

SimpleGift wrote:
Sat Jun 23, 2018 7:05 pm
...Mr. Lowenfeld's advice still seems sound over 100 years later — though the diversification benefits may be a bit less today...
In your portfolio, you give equal weight to the United States and Central America?
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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by SimpleGift » Sat Jun 23, 2018 8:37 pm

nisiprius wrote:
Sat Jun 23, 2018 8:08 pm
SimpleGift wrote:
Sat Jun 23, 2018 7:05 pm
...Mr. Lowenfeld's advice still seems sound over 100 years later — though the diversification benefits may be a bit less today...
In your portfolio, you give equal weight to the United States and Central America?
Obviously not — but I'm fairly certain the concept of diversification by market capitalization was not on the radar in Mr. Lowenfeld's time. His stock diversification recommendations were equal-weighted, with a sensible accumulation strategy:
Henry Lowenfeld in 1906 wrote:"In our opinion, the evolution of invested savings should be somewhat as follows: When annual earnings first begin to exceed the annual expenditure, the Post Office Savings Bank should be the repository for any up to the first 100 pounds. As soon as the deposits reach that figure, they should be taken out and invested in one stock.

This process should be repeated with the next 100 pounds, only the second stock chosen must be under a different market and trade influence from the first."
He recommended that investors continue the process, adding additional stocks from different world trading zones with each additional 100 pounds, to gradually produce a diversified, multi-stock, approximately equal-weighted stock portfolio.
Last edited by SimpleGift on Sat Jun 23, 2018 8:46 pm, edited 1 time in total.
Cordially, Todd

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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by jbranx » Sat Jun 23, 2018 8:43 pm

Thanks, Simplegift. As Peter Bernstein pointed out in his excellent "Capital Ideas," lots of the theorists we all know today stood on the shoulders of others. Witness this paragraph on market efficiency by E. Dimson, and M. Mussavian, re Bachelier:

The concept of market efficiency had been anticipated at the beginning of the century in the
dissertation submitted by Bachelier (1900) to the Sorbonne for his PhD in mathematics. In his
opening paragraph, Bachelier recognises that "past, present and even discounted future events are
reflected in market price, but often show no apparent relation to price changes".

This recognition of the informational efficiency of the market leads Bachelier to continue,
in his opening paragraphs, that "if the market, in effect, does not predict its fluctuations, it does
assess them as being more or less likely, and this likelihood can be evaluated mathematically".
This gives rise to a brilliant analysis that anticipates not only Albert Einstein's subsequent derivation
of the Einstein-Wiener process of Brownian motion, but also many of the analytical results that
were rediscovered by finance academics in the second half of the century. Sadly, Bachelier's
contribution was overlooked....

European Financial Management, Volume 4, Number 1, March 1998, pp 91-193

I don't remember exactly, but I think Bernstein said Bachelier first made his observations by looking at the prices of commodities traded at the time.

EDIT: The authors go on to point out that the Bachelier paper was unknown in the US until Paul Samuelson circulated it in the '50's. Also, they do say he studied commodity prices to draw his conclusions.

The full 14-page PDF by the authors on market efficiency can be found here:

http://citeseerx.ist.psu.edu/viewdoc/do ... 1&type=pdf
Last edited by jbranx on Sat Jun 23, 2018 8:51 pm, edited 1 time in total.

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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by JoMoney » Sat Jun 23, 2018 8:46 pm

SimpleGift wrote:
Sat Jun 23, 2018 8:37 pm
... He recommended investors continue the process, adding additional stocks from different world trading zones with each additional 100 pounds, to gradually produce a diversified, multi-stock, approximately equal-weighted stock portfolio.
Did he suggest they "rebalance" to maintain equal weight? If not, a buy-and-hold approach might over time start to resemble something like a cap-weighted or price-weighted portfolio.
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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by siamond » Sat Jun 23, 2018 8:51 pm

Not only domestic diversification, but also international diversification? In 1906? That was a clever man. Some on this board may want to heed his wisdom... :wink:

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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by Snowjob » Sat Jun 23, 2018 8:51 pm

I started investing back in 2006.

Since then, international has been a dog. A US stock portfolio would have generated 9% a year while a global (50/50) would have been 7%.

Go back to 1998 when total international started and the performance difference would be even more pronounced since most of the performance happened in the last 10 years while portfolio assets would have been much larger. Sometimes its better to be lucky than good? The average Joe who just bought the S&P 500 would be sitting on far more wealth than someone in the global portfolio.

They say if you buy the index you'll not have that fear of under-performing the market, but if your buying the global market and everyone around is buying the US market you can still have that performance disconnect. All the history tells me (and thanks for posting this by the way) that the smart move is to go with the global portfolio but if international continues to under-perform that's a real problem. Not only does the global investor have to battle the behavioral urge to change course and lock in years of under-performance and switch to a domestic allocation, but if their peers domestically have realized far better returns their local purchasing power this pushes that individual down the economic food chain. I faith that I can marginally out save my peers and have a comfortable retirement, but if they all earn 1-2% more than I do on that savings, over time it will be as If I under-saved. Decisions, decisions. What matters more, absolute performance or relative performance (to your domestic peers)

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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by SimpleGift » Sat Jun 23, 2018 8:53 pm

JoMoney wrote:
Sat Jun 23, 2018 8:46 pm
SimpleGift wrote:
Sat Jun 23, 2018 8:37 pm
... He recommended investors continue the process, adding additional stocks from different world trading zones with each additional 100 pounds, to gradually produce a diversified, multi-stock, approximately equal-weighted stock portfolio.
Did he suggest they "rebalance" to maintain equal weight? If not, a buy-and-hold approach might over time start to resemble something like a cap-weighted or price-weighted portfolio.
Good point, JoMoney. There's no mention of rebalancing that I saw in his 1906 treatise, so the portfolios would begin to deviate from equal-weighting as time went on.
Cordially, Todd

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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by mindboggling » Sat Jun 23, 2018 8:56 pm

Very interesting. Thank you!
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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by arcticpineapplecorp. » Sat Jun 23, 2018 9:04 pm

Snowjob wrote:
Sat Jun 23, 2018 8:51 pm
I started investing back in 2006.

Since then, international has been a dog. A US stock portfolio would have generated 9% a year while a global (50/50) would have been 7%.

Go back to 1998 when total international started and the performance difference would be even more pronounced since most of the performance happened in the last 10 years while portfolio assets would have been much larger. Sometimes its better to be lucky than good? The average Joe who just bought the S&P 500 would be sitting on far more wealth than someone in the global portfolio.

They say if you buy the index you'll not have that fear of under-performing the market, but if your buying the global market and everyone around is buying the US market you can still have that performance disconnect. All the history tells me (and thanks for posting this by the way) that the smart move is to go with the global portfolio but if international continues to under-perform that's a real problem. Not only does the global investor have to battle the behavioral urge to change course and lock in years of under-performance and switch to a domestic allocation, but if their peers domestically have realized far better returns their local purchasing power this pushes that individual down the economic food chain. I faith that I can marginally out save my peers and have a comfortable retirement, but if they all earn 1-2% more than I do on that savings, over time it will be as If I under-saved. Decisions, decisions. What matters more, absolute performance or relative performance (to your domestic peers)
But you're forgetting another benefit of diversification by holding international, which is reduced volatility:

Image

https://personal.vanguard.com/pdf/ISGGEB.pdf

Don't bonds reduce the volatility of one's portfolio? Yes. And don't bonds generally reduce one's returns as well? Yes. Of course international stocks won't reduce returns nearly as much as bonds but anything that is more diversified could lower returns. There can really only be one best asset class. Problem is, we don't know which it will be. If we did, wouldn't we just put all our eggs in that basket? You'd be foolish not to. You're making the assumption (cognitive error) that just because the U.S. did better in the past, it will continue to do so in the future. It might. It might not. Since we don't know, we have to diversify our assets as much as we can (in the asset classes that have had positive real returns).

I believe Jack Bogle has said he has half in bonds and half in stocks. Half the time he worries he has too much in stocks. And the other half of the time he worries he has too little in stocks. The same can be said of international stocks, U.S. stocks, etc. ad naseum (you can do the same with value, small cap, other new factor tilts like momentum, quality, profitability, low vol, etc). You'll never know what will be the best in advance. So decide on an allocation and stick with it. There will always be portfolios that will do better than whatever one you happen to settle on:

https://www.whitecoatinvestor.com/150-p ... han-yours/
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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by patrick013 » Sat Jun 23, 2018 9:25 pm

While some Intl's are having good years some are having
bad years currency exchange wise. So yeah, foreign
investing stays boring again.

Old investors would profiteer wherever they could. Not
bad for those seeking profit. Not as automated as it is now.
age in bonds, buy-and-hold, 10 year business cycle

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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by SimpleGift » Sat Jun 23, 2018 10:41 pm

Upon reflection, it's really no wonder that U.K. investors in the late 1800s developed basic concepts of portfolio diversification. They were faced with a bewildering choice of securities, each with very different risks and characteristics, and from all parts of the world (for example, table below). In short, they could hardly avoid the issue of portfolio risk and diversification!
  • Number of government bonds traded on the London Stock Exchange
    Image
    Source: Goetzmann et al
British government bonds were of course considered the risk-free investment of the time — but if one wanted to invest in riskier securities (from Beeton's Guide to Investing Money with Safety and Profit, published in 1870):
Beeton's Guide wrote:"...he should divide his capital among a number of securities that can be bought to pay a high rate of interest – the more the better. Supposing he has £500 to invest, let him invest £100 in each of the following – Turkish, Italian, Spanish, Egyptian, Guatemalan, or Argentine. By dividing his capital in this way, the investor reduces risk to a minimum, as it is unlikely that all these countries could stop paying their interest, although it is not unlikely that any one might do so."
PS. My understanding is there was minimal foreign currency exchange risk on these bond investments in the late 1800s, as most countries around the world were on (or in the process of adopting) the gold standard.
Cordially, Todd

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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by nedsaid » Sun Jun 24, 2018 12:09 am

siamond wrote:
Sat Jun 23, 2018 8:51 pm
Not only domestic diversification, but also international diversification? In 1906? That was a clever man. Some on this board may want to heed his wisdom... :wink:
Mr. Bogle, are you listening?
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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by Always passive » Sun Jun 24, 2018 12:29 am

From the Bible...

Solomon in Ecclesiastes 11:2:

“Divide your portion to seven, or even to eight, for you do not know what misfortune may occur on the earth.”

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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by grok87 » Sun Jun 24, 2018 5:17 am

Always passive wrote:
Sun Jun 24, 2018 12:29 am
From the Bible...

Solomon in Ecclesiastes 11:2:

“Divide your portion to seven, or even to eight, for you do not know what misfortune may occur on the earth.”
Thanks. Here’s the full passage (for context) in the NIV
“” wrote: Invest in Many Ventures
11 Ship your grain across the sea;
after many days you may receive a return.
2 Invest in seven ventures, yes, in eight;
you do not know what disaster may come upon the land.
3 If clouds are full of water,
they pour rain on the earth.
Whether a tree falls to the south or to the north,
in the place where it falls, there it will lie.
4 Whoever watches the wind will not plant;
whoever looks at the clouds will not reap.
5 As you do not know the path of the wind,
or how the body is formed[a] in a mother’s womb,
so you cannot understand the work of God,
the Maker of all things.
6 Sow your seed in the morning,
and at evening let your hands not be idle,
for you do not know which will succeed,
whether this or that,
or whether both will do equally well.
It’s a little hard to parse. Do the 7/8 ventures relate to the grain shipping? If so it’s hard to understand the “land” reference? Unless the idea is “diversify internationally” (by shipping your grain to like 8 different places) in case we get invaded and wiped out locally by a conquering army. Would love to know what the original text says.
Keep calm and Boglehead on. KCBO.

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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by grok87 » Sun Jun 24, 2018 5:21 am

Random Walker wrote:
Sat Jun 23, 2018 6:58 pm
"Let every man divide his money into three parts, and invest a third in land, a third in business and a third let him keep by him in reserve."

Talmud, circa 1200 B.C
Yep. Quoted by David Swensen and Gibson before him
Keep calm and Boglehead on. KCBO.

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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by grok87 » Sun Jun 24, 2018 7:43 am

Merchant of Venice act 1 scene 1
“” wrote: SALANIO
Believe me, sir, had I such venture forth,
The better part of my affections would
Be with my hopes abroad. I should be still
Plucking the grass, to know where sits the wind,
Peering in maps for ports and piers and roads;
And every object that might make me fear
Misfortune to my ventures, out of doubt
Would make me sad.
SALARINO
My wind cooling my broth
Would blow me to an ague, when I thought
What harm a wind too great at sea might do.
I should not see the sandy hour-glass run,
But I should think of shallows and of flats,
And see my wealthy Andrew dock'd in sand,
Vailing her high-top lower than her ribs
To kiss her burial. Should I go to church
And see the holy edifice of stone,
And not bethink me straight of dangerous rocks,
Which touching but my gentle vessel's side,
Would scatter all her spices on the stream,
Enrobe the roaring waters with my silks,
And, in a word, but even now worth this,
And now worth nothing? Shall I have the thought
To think on this, and shall I lack the thought
That such a thing bechanced would make me sad?
But tell not me; I know, Antonio
Is sad to think upon his merchandise.
ANTONIO
Believe me, no: I thank my fortune for it,
My ventures are not in one bottom trusted,
Nor to one place; nor is my whole estate
Upon the fortune of this present year:
Therefore my merchandise makes me not sad.
Keep calm and Boglehead on. KCBO.

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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by SimpleGift » Sun Jun 24, 2018 11:15 am

grok87 wrote:
Sun Jun 24, 2018 7:43 am
Merchant of Venice act 1 scene 1
Shakespeare wrote: ANTONIO
Believe me, no: I thank my fortune for it,
My ventures are not in one bottom trusted,
Nor to one place; nor is my whole estate
Upon the fortune of this present year:
Therefore my merchandise makes me not sad.
Thanks, grok. It's interesting that Harry Markowitz himself wrote a history of how Modern Portfolio Theory was developed, and while he references several influential papers from the 1930s and 1940s, the Merchant of Venice quote above was the only "deep history" reference he included in his paper.

The Early History of Portfolio Theory: 1600-1960

His omission of portfolio diversification concepts from the U.K. in the 1800s is notable — however, these seem to have been more functional and practice-oriented to suit the times, rather than on the road to any grand theory of diversification.
Cordially, Todd

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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by siamond » Sun Jun 24, 2018 1:19 pm

SimpleGift, please allow me to side-track a tiny bit.

Did you read "Against the Gods: The Remarkable Story of Risk" by Peter Bernstein? I just finished it. If you did not, then go for it, you'll have a blast... Such a truly remarkable book. And a very witty title.

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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by spdoublebass » Sun Jun 24, 2018 1:22 pm

grok87 wrote:
Sun Jun 24, 2018 5:17 am
by shipping your grain to like 8 different places) in case we get invaded and wiped out locally by a conquering army. Would love to know what the original text says.
In the first verse, in the original Hebrew, a ship is never mentioned.

Hebrew reads: Throw your bread on the waters,/for after many days you will find it again.

which in the NLT translation is:
Give generously,/ for your gifts will return to you later.

My only point is that it's not literally about shipping goods somewhere.
I'm trying to think, but nothing happens

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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by SimpleGift » Sun Jun 24, 2018 1:41 pm

siamond wrote:
Sun Jun 24, 2018 1:19 pm
SimpleGift, please allow me to side-track a tiny bit.

Did you read "Against the Gods: The Remarkable Story of Risk" by Peter Bernstein? I just finished it. If you did not, then go for it, you'll have a blast... Such a truly remarkable book. And a very witty title.
Thank you for the recommendation, siamond. I've been vaguely aware of this book, but have never read it.

The Look Inside! preview at Amazon indicates this book will fit in nicely with the "deep history" of investing jag that I seem to have been on lately! Look forward to reading it.
Cordially, Todd

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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by siamond » Sun Jun 24, 2018 1:46 pm

SimpleGift wrote:
Sun Jun 24, 2018 1:41 pm
siamond wrote:
Sun Jun 24, 2018 1:19 pm
SimpleGift, please allow me to side-track a tiny bit.

Did you read "Against the Gods: The Remarkable Story of Risk" by Peter Bernstein? I just finished it. If you did not, then go for it, you'll have a blast... Such a truly remarkable book. And a very witty title.
Thank you for the recommendation, siamond. I've been vaguely aware of this book, but have never read it.

The Look Inside! preview at Amazon indicates this book will fit in nicely with the "deep history" of investing jag that I seem to have been on lately! Look forward to reading it.
Yup, this will fit very well, no doubt. And then of course, there is the absolute classic (Devil Take the Hindmost: A History of Financial Speculation by Edward Chancellor), but this one, I am ready to bet that you read it already.

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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by Snowjob » Sun Jun 24, 2018 8:19 pm

arcticpineapplecorp. wrote:
Sat Jun 23, 2018 9:04 pm
...
You're making the assumption (cognitive error) that just because the U.S. did better in the past, it will continue to do so in the future. It might. It might not. Since we don't know, we have to diversify our assets as much as we can (in the asset classes that have had positive real returns).

I believe Jack Bogle has said he has half in bonds and half in stocks. Half the time he worries he has too much in stocks. And the other half of the time he worries he has too little in stocks. Th
....
I fully understand the past is not a guarantee of future results. I'm just of the mind that taking the global weights on equity is akin to taking a 50% tilt in your portfolio relative to the average US investor (with whom I am competing with for goods and services in the future). The larger the tilt the larger the divergence (positive or negative).

Consider this -- If we all invest in the S&P but the next 20 years does something like 2-3% real returns, I know I'll be ok, and in a much better situation than most since I save more than my peers. If the market performs as it has in the past, we'll all be comfortable but I'll just end up with extra money or the ability to retire earlier than most. In either case, I've reduced the factors driving my future wealth down to savings rate.

If on the other hand I chose to deviate from the crowd and go with a global portfolio (50% international) I'm making a massive bet with the driver of my future wealth. this could benefit me, but as I noted above, I'm already doing enough to outpace my peers. On the other hand I could suffer from sever underperformance. In this case I've taken on potentially a lot of risk in order to ensure against the unlikely chance that my home country's market will underperform expectations by a wide margin -- a scenario that I am already working to avoid by simply saving more than the average person does / is told to save.

Long way of saying, a smaller tilt might be more palatable than going right in to the full market allocation because relative performance (relative to that of your peers) matters. If everyone in the US had a default global portfolio of equities, then it would be a no brainer. Take the diversification benefits of a global portfolio and not worry about underperforming your peers on portfolio selection!

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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by arcticpineapplecorp. » Sun Jun 24, 2018 8:54 pm

Snowjob wrote:
Sun Jun 24, 2018 8:19 pm
If on the other hand I chose to deviate from the crowd and go with a global portfolio (50% international) I'm making a massive bet with the driver of my future wealth. this could benefit me, but as I noted above, I'm already doing enough to outpace my peers. On the other hand I could suffer from sever underperformance. In this case I've taken on potentially a lot of risk in order to ensure against the unlikely chance that my home country's market will underperform expectations by a wide margin -- a scenario that I am already working to avoid by simply saving more than the average person does / is told to save.

Long way of saying, a smaller tilt might be more palatable than going right in to the full market allocation because relative performance (relative to that of your peers) matters. If everyone in the US had a default global portfolio of equities, then it would be a no brainer. Take the diversification benefits of a global portfolio and not worry about underperforming your peers on portfolio selection!
Few things:

1. I'm glad you're oversaving relative to the "average" person. As you say, that will help you regardless of what returns are. However, truly what others do is of no consequence to you.

2. When you say "severe underperformance" you're saying what if the global portfolio underperforms one market (the U.S. for instance)? This is only true to the extent that the global market does worse than any one market (like U.S. alone). But if you invest in the global market you can't underperform the global market. You'll get the global return. There's no underperformance of the global market. Can there be underperformance of the global market relative to one market alone (U.S.)? Yes. But the global market can underperform relative to one sector, or one stock, one asset class, ad naseum. To do anything other than hold the global portfolio (hold U.S. only and not global market) is akin to saying "I think X sector is going to outperform Y market so I don't want to invest in Y market only to 'severely underperform' X sector".

3. I don't compare my performance (relative or otherwise) to my peers. I'm trying to get my assets to outpace inflation. I'm not trying to beat the market. I'm not trying to beat my peers. I'm not trying to beat the "average" person. I'm not trying to have the best portfolio selection for highest return because I can't know that in advance.

I think no matter what you choose, you will always have the option of being disappointed. If you happen to choose the allocation that outperforms all others, isn't that really nothing more than a matter of luck? We're trying to avoid luck by diversifying as widely as possible.
"Invest we must." -- Jack Bogle | “The purpose of investing is not to simply optimise returns and make yourself rich. The purpose is not to die poor.” -- William Bernstein

grok87
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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by grok87 » Sun Jun 24, 2018 8:57 pm

spdoublebass wrote:
Sun Jun 24, 2018 1:22 pm
grok87 wrote:
Sun Jun 24, 2018 5:17 am
by shipping your grain to like 8 different places) in case we get invaded and wiped out locally by a conquering army. Would love to know what the original text says.
In the first verse, in the original Hebrew, a ship is never mentioned.

Hebrew reads: Throw your bread on the waters,/for after many days you will find it again.

which in the NLT translation is:
Give generously,/ for your gifts will return to you later.

My only point is that it's not literally about shipping goods somewhere.
thanks, that's interesting.
Keep calm and Boglehead on. KCBO.

grok87
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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by grok87 » Sun Jun 24, 2018 8:59 pm

SimpleGift wrote:
Sun Jun 24, 2018 11:15 am
grok87 wrote:
Sun Jun 24, 2018 7:43 am
Merchant of Venice act 1 scene 1
Shakespeare wrote: ANTONIO
Believe me, no: I thank my fortune for it,
My ventures are not in one bottom trusted,
Nor to one place; nor is my whole estate
Upon the fortune of this present year:
Therefore my merchandise makes me not sad.
Thanks, grok. It's interesting that Harry Markowitz himself wrote a history of how Modern Portfolio Theory was developed, and while he references several influential papers from the 1930s and 1940s, the Merchant of Venice quote above was the only "deep history" reference he included in his paper.

The Early History of Portfolio Theory: 1600-1960

His omission of portfolio diversification concepts from the U.K. in the 1800s is notable — however, these seem to have been more functional and practice-oriented to suit the times, rather than on the road to any grand theory of diversification.
huh, that's neat.
Keep calm and Boglehead on. KCBO.

Snowjob
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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by Snowjob » Mon Jun 25, 2018 12:27 am

arcticpineapplecorp. wrote:
Sun Jun 24, 2018 8:54 pm

Few things:

1. I'm glad you're oversaving relative to the "average" person. As you say, that will help you regardless of what returns are. However, truly what others do is of no consequence to you.

2. When you say "severe underperformance" you're saying what if the global portfolio underperforms one market (the U.S. for instance)? This is only true to the extent that the global market does worse than any one market (like U.S. alone). But if you invest in the global market you can't underperform the global market. You'll get the global return. There's no underperformance of the global market. Can there be underperformance of the global market relative to one market alone (U.S.)? Yes. But the global market can underperform relative to one sector, or one stock, one asset class, ad naseum. To do anything other than hold the global portfolio (hold U.S. only and not global market) is akin to saying "I think X sector is going to outperform Y market so I don't want to invest in Y market only to 'severely underperform' X sector".

3. I don't compare my performance (relative or otherwise) to my peers. I'm trying to get my assets to outpace inflation. I'm not trying to beat the market. I'm not trying to beat my peers. I'm not trying to beat the "average" person. I'm not trying to have the best portfolio selection for highest return because I can't know that in advance.

I think no matter what you choose, you will always have the option of being disappointed. If you happen to choose the allocation that outperforms all others, isn't that really nothing more than a matter of luck? We're trying to avoid luck by diversifying as widely as possible.

2.) I agree with this. Great, I get the global return, I have no desire to out perform the market, odds are I wont.

1.) I disagree with this, which is the foundation of our disagreement. If everyone else in the US earns 8% a year over their investing lives by investing in the US market and I only earn 5% (pushing the gap to make a point) using a global allocation that ends up at a near 3:1 wealth differential. I am now at a massive disadvantage in my local economy when it comes to securing goods and services.

3.) I think ignoring how others are doing works when your buying an index and everyone else is trying to beat the market. There will be winners and losers, and you don't to make foolish decisions out of the jealousy of the few who happened to end up with fortunate outcomes. As we move to passive era where everyone tries to own the index this become a different question. in the extreme example, we all own index X meaning we all have the same growth engine. now that the randomness of returns are gone, its down to savings.

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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by GAAP » Mon Jun 25, 2018 10:42 am

In the late 1800s, the UK was the dominant economy, and the financial wisdom said diversify internationally.

Today, the US is the dominant economy, and the financial wisdom says international isn't needed.

The UK is no longer the dominant economy, so why is now appropriate to assume that the US will remain the dominant economy?

Empires fall -- I see no reason that justifies an assumption that this one won't. The specific reasoning behind international diversification has nothing to do with day-to-day returns, or even decade-to-decade returns. It's about economic (cross-economy) risk diversification.

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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by SimpleGift » Mon Jun 25, 2018 11:55 am

GAAP wrote:
Mon Jun 25, 2018 10:42 am
In the late 1800s, the UK was the dominant economy, and the financial wisdom said diversify internationally.
Today, the US is the dominant economy, and the financial wisdom says international isn't needed.
The UK is no longer the dominant economy, so why is now appropriate to assume that the US will remain the dominant economy?
No doubt that major world economies have risen and fallen in their relative global dominance, even within 50-year spans that a typical investor might be in the market (chart below). So your point about international diversification is a good one, in my view.
What was unique about the U.K. market in the late 1800s is that international diversification was so easy to accomplish (from what I've read). The London Stock Exchange was the central hub for the world's stocks and bonds. Though many other countries had exchanges, these were seen largely as proving grounds for domestic companies, until they were ready to make the leap to London (and later the NYSE). Plus, most countries were on the gold standard, so there was minimal currency exchange risk.

Though times have changed, the ease and low cost of diversification today for the global investor appears somewhat similar.
Last edited by SimpleGift on Mon Jun 25, 2018 12:19 pm, edited 1 time in total.
Cordially, Todd

Snowjob
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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by Snowjob » Mon Jun 25, 2018 12:12 pm

GAAP wrote:
Mon Jun 25, 2018 10:42 am
In the late 1800s, the UK was the dominant economy, and the financial wisdom said diversify internationally.

Today, the US is the dominant economy, and the financial wisdom says international isn't needed.

The UK is no longer the dominant economy, so why is now appropriate to assume that the US will remain the dominant economy?
Definitely one of the reasons I'd love to hold the global market cap.

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FreeAtLast
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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by FreeAtLast » Mon Jun 25, 2018 12:28 pm

Very educational and enjoyable thread. Thank you, SimpleGift, and everybody else who posted their enlightening replies. :happy
Illegitimi non carborundum.

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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by arcticpineapplecorp. » Mon Jun 25, 2018 5:04 pm

Snowjob wrote:
Mon Jun 25, 2018 12:27 am
1.) I disagree with this, which is the foundation of our disagreement. If everyone else in the US earns 8% a year over their investing lives by investing in the US market and I only earn 5% (pushing the gap to make a point) using a global allocation that ends up at a near 3:1 wealth differential. I am now at a massive disadvantage in my local economy when it comes to securing goods and services.
You're free to move to a cheaper location. Many do just that and not because their investment performance didn't keep pace with their neighbors. Many areas of high growth have higher rates of inflation (for housing for instance). You're assuming everyone else can afford it but you can't if you get lower returns. But in truth everyone in that area may be struggling if the cost of living in a particular area rises faster than their investments or income.

Besides, when you're older aren't you going to have a less risky portoflio anyway? Say 50-50 or 30-70 for instance? If you continue to reduce risk over time you will likely reduce returns. So you could wind up with lower returns than others anyway, even if you're all U.S. In other words, your 20 to 30 something peers might be outperforming you anyway even if you have identical investments, but the allocation of those investments differs.

Finally, if you want the highest return, you'd pick the country that does the best right? I mean, you're assuming U.S. will do better than international, but isn't it likely that some international (or emerging market) country might do better than the U.S.? While the U.S. got 21% last year wouldn't you have wanted some Austria instead (or in addition) which was up 58% last year? In 2016 while the U.S earned 10.9% Canada was up 24.6%. In 2011 the U.S. was just up 1.4% while Ireland was up 13.7%. And so on...

Image

source: https://www.ifa.com/pdf/matrix%20book%202018.pdf
check out page 44 of 47 (link above)

Know what the best performing country was in 2017? Austria
Know what the best performing country was in 2016? Brazil (emerging markets)
Know what the best performing country was in 2015? Hungary (emerging markets)
Know what the best performing country was in 2014? Egypt (emerging markets)
Know what the best performing country was in 2013? Finland

And so on. While the U.S was the top dog in just one year going back to 1998 (in 2014) it's return (12.7%) paled in comparison to Egypt's (29.3%).

Food for thought.

Image
"Invest we must." -- Jack Bogle | “The purpose of investing is not to simply optimise returns and make yourself rich. The purpose is not to die poor.” -- William Bernstein

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SimpleGift
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Re: Portfolio Diversification, Long Before Mr. Markowitz

Post by SimpleGift » Mon Jun 25, 2018 6:06 pm

In a PM, a Forum member asked whether there was any data on the relative degree of trade liberalism and globalization in the late 1800s, and whether this might have been motivating investors' interest in international diversification back then.

A little sleuthing turned up the chart below. Certainly the late 1800s was an era of increased globalization and trade openness (in blue, measured as the ratio of imports plus exports to global GDP). Financial openness was also relatively high (in red, measured as investment assets held by foreigners as a share of global GDP). All this openness apparently collapsed after 1930, as protectionism dominated the interwar period.
So it's probably not a coincidence that investor interest in international diversification again surfaced in the 1970s-1980s, just as trade liberalism and globalization was again on the rise. Thanks to the Forum member who suggested looking at this!
Cordially, Todd

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