Bogleheads® 2022 Conference – Bogleheads University

00:00:00.000 | (audience applauding)

00:00:03.160 | - Hi, me again.

00:00:09.520 | I have some of the easiest units in the course here

00:00:12.960 | because I think these are things

00:00:14.200 | that most of us agree upon.

00:00:16.240 | But I'm gonna talk a little bit

00:00:17.440 | about the merits of diversification.

00:00:19.760 | I think most of us fully understand

00:00:21.520 | the value of asset class diversification,

00:00:24.480 | intra-asset class diversification.

00:00:26.200 | But I'm gonna dive into that a little bit.

00:00:28.000 | And I'm also gonna talk about time period diversification,

00:00:30.560 | which I touched on in my earlier comments

00:00:33.600 | about dollar cost averaging.

00:00:37.520 | So Jack Bogle, once again, said it really well

00:00:40.520 | about the merits of diversification.

00:00:42.520 | He said, "Absolutely no one knows

00:00:44.800 | "what the stock market is going to do tomorrow,

00:00:47.020 | "let alone next year,

00:00:48.540 | "nor which sector, style or region will lead

00:00:51.680 | "and which will lag behind.

00:00:53.480 | "Given this absolute uncertainty,"

00:00:55.400 | and I can just hear it in his booming voice,

00:00:57.840 | "the most logical strategy

00:00:59.440 | "is to invest as broadly as possible."

00:01:02.060 | Nobel Laureate Harry Markowitz said a version

00:01:05.960 | of the same thing.

00:01:06.960 | Markowitz, of course, was the path-breaking

00:01:10.640 | researcher in modern portfolio theory.

00:01:14.840 | He said of diversification,

00:01:16.940 | "A good portfolio is more than a long list

00:01:19.060 | "of good stocks and bonds.

00:01:20.720 | "It is a balanced whole providing the investor

00:01:23.380 | "with protections and opportunities

00:01:25.660 | "with respect to a wide range of contingencies."

00:01:28.920 | So both Bogle and Markowitz said here

00:01:32.440 | that there's so much that we don't know about the future.

00:01:35.560 | We don't know what the next catastrophe

00:01:38.240 | or wonderful thing to come along might be.

00:01:40.840 | And so the best idea is to invest with humility,

00:01:45.440 | invest with a sense that we can't predict the future,

00:01:49.460 | so the best way to go is to build a portfolio

00:01:53.240 | given our time horizon that helps set us up

00:01:56.860 | for reasonable returns regardless of what happens.

00:02:01.660 | So the key benefits of diversification

00:02:03.960 | I'll just quickly outline.

00:02:05.680 | One is that it helps ensure that any given point in time,

00:02:08.860 | something, anything in your portfolio

00:02:11.520 | is performing reasonably well.

00:02:13.560 | In 2022, unfortunately, that's a really short list

00:02:16.780 | of like cash, not great even on an inflation-adjusted basis,

00:02:20.960 | but at least positive.

00:02:22.420 | Value stocks have certainly held up better

00:02:25.260 | than growth this year.

00:02:27.460 | Energy stocks, at least until recently,

00:02:31.260 | had done reasonably well.

00:02:32.660 | So there have been a few bright spots,

00:02:34.580 | but that's the value of diversification,

00:02:36.460 | that you've always got something

00:02:37.880 | in your portfolio that works.

00:02:40.260 | Diversification also guarantees

00:02:42.320 | that you won't choose precisely wrong,

00:02:45.220 | either about the asset class or the specific stock

00:02:49.620 | within the equity asset class

00:02:51.820 | or the specific time period in which to invest.

00:02:56.100 | So it helps minimize regret,

00:02:58.980 | which it turns out is a really valuable thing

00:03:01.260 | in terms of helping us stick with our plan.

00:03:04.660 | And finally, diversification helps reduce

00:03:07.500 | the volatility of our portfolios.

00:03:09.580 | So just having things in our portfolios

00:03:11.980 | that behave differently helps bring the risk down.

00:03:15.660 | It helps bring the standard deviation down.

00:03:18.180 | Again, that helps us stick with our plans.

00:03:21.220 | So this is a slide.

00:03:22.180 | I'll just describe what we're looking at.

00:03:24.220 | This is something that my colleague,

00:03:25.560 | Amy Arnott, put together.

00:03:27.560 | But we did some research where we looked

00:03:30.620 | at correlations among asset classes.

00:03:34.260 | And what you can see, and maybe you can't see,

00:03:36.320 | maybe it's too tiny, but what you can see

00:03:38.200 | is that the more assets that you add,

00:03:42.180 | that helps reduce the standard deviation

00:03:45.100 | or the volatility of the portfolio.

00:03:47.660 | And that's especially true if you add assets

00:03:50.860 | that behave differently.

00:03:52.500 | So Alan was talking a little bit

00:03:54.260 | about the value of doing that.

00:03:56.300 | So as you see things really taper down there

00:03:59.520 | in terms of standard deviation,

00:04:01.540 | that's more assets and that's more assets

00:04:04.540 | that are uncorrelated.

00:04:06.380 | Focusing on those two things can help bring down

00:04:09.800 | the risk level, the volatility level of a portfolio.

00:04:13.740 | So there are multiple ways to diversify.

00:04:15.860 | I hinted at a few of them.

00:04:17.560 | By asset class, that's the one that most of us think about.

00:04:21.220 | And Jim Dolly talked about the value

00:04:24.380 | of asset class diversification in terms

00:04:27.460 | of how our portfolios behave in terms of their returns,

00:04:30.740 | but it also translates into how it behaves

00:04:35.100 | in terms of volatility.

00:04:36.340 | So asset class diversification,

00:04:38.220 | that's usually most of our first stop

00:04:40.720 | on the road to diversification.

00:04:42.740 | Within asset classes, also super important.

00:04:45.980 | So you want stocks in your portfolio,

00:04:48.640 | you don't just want a couple of stocks, right?

00:04:51.140 | That's something Bogleheads know.

00:04:52.720 | They know the value of diversifying across multiple stocks,

00:04:57.160 | which is something that you get

00:04:58.340 | with those big broad index fund portfolios.

00:05:02.160 | Across account types, Jim Dolly talked

00:05:05.640 | about tax diversification.

00:05:08.920 | It's something we don't talk about as much,

00:05:10.840 | but when you come into retirement

00:05:12.800 | and you have multiple pools of assets

00:05:14.860 | that you can pull from,

00:05:16.340 | that tax diversification really comes in handy.

00:05:19.280 | And finally, by time period.

00:05:22.520 | That diversifying your purchases by time period

00:05:25.320 | helps ensure that you have a variety of market returns

00:05:30.320 | that each dollar is able to benefit from.

00:05:35.120 | This is just a slide

00:05:36.440 | that illustrates asset class diversification.

00:05:38.840 | I pulled this from some of our research

00:05:40.560 | on asset correlations.

00:05:42.440 | What you can see is that at least until prior to 2022,

00:05:47.320 | stocks had a nice, not fully negative correlation

00:05:52.320 | with U.S. Treasury bonds,

00:05:55.680 | but in some market environments,

00:05:57.340 | indeed a negative correlation.

00:05:59.300 | We've seen a little bit of a reversal of that this year

00:06:01.880 | where stocks and bonds have been moving in sympathy,

00:06:06.500 | but in many market environments,

00:06:08.100 | we have seen that nice diversifying ability

00:06:11.460 | for those two assets.

00:06:12.820 | And cash is the other asset class

00:06:14.940 | that appears on this screen.

00:06:16.420 | But remember, you can overdo diversification.

00:06:21.140 | It's diversification, not, I think Rick Ferry said,

00:06:25.100 | maybe someone else did as well,

00:06:27.100 | it's not de-worsification.

00:06:29.420 | And this is such an important point

00:06:31.460 | that you can overdo diversification.

00:06:33.700 | In fact, I would say this is one of the main problems

00:06:36.980 | I see in the portfolios that I review

00:06:39.220 | for these portfolio makeovers that I do.

00:06:42.520 | People have portfolios that are crazily complicated

00:06:47.520 | given their assets.

00:06:49.300 | They've assumed that more is more.

00:06:51.460 | And I do wonder if there's a little bit of a wealth effect

00:06:55.160 | that people feel if they feel like

00:06:57.100 | they've assembled a lot of funds

00:06:59.100 | or a lot of investments in a portfolio.

00:07:01.420 | Even if they just have little bits in them,

00:07:04.100 | I think it might make them feel wealthier.

00:07:06.860 | But the problem with overdoing diversification

00:07:10.660 | is that it makes it really difficult to see what you've got.

00:07:14.020 | It makes it difficult to keep track

00:07:16.140 | of your portfolio's asset allocation,

00:07:18.820 | makes it difficult to figure out

00:07:20.300 | where you need to make adjustments

00:07:22.100 | if your asset allocation gets off track.

00:07:25.380 | So less is more in terms of moving parts in a portfolio.

00:07:30.380 | My view is that you can be quite minimalist

00:07:35.140 | on a per-account basis,

00:07:37.500 | and you can even be minimalist across account types.

00:07:41.820 | In fact, I was recently working with a woman

00:07:43.920 | on her portfolio makeover,

00:07:45.960 | and she had a really good equity fund in her 401(k),

00:07:50.960 | and they wanted to have kind of an ESG portfolio.

00:07:54.580 | And the net effect,

00:07:55.680 | because they didn't have a lot of funds,

00:07:57.340 | was that when I looked at it, I said,

00:08:00.100 | I think, forget intra-asset class diversification

00:08:03.380 | for this small 401(k) portfolio.

00:08:05.860 | Just put it all in that ESG index fund

00:08:09.780 | and fill out the other asset classes

00:08:13.020 | with other parts of your portfolio,

00:08:15.100 | with your husband's IRA and so forth.

00:08:17.540 | So this is especially true.

00:08:19.340 | You can get away with fewer holdings

00:08:21.340 | if you have mutual funds and ETFs,

00:08:24.220 | especially if you have broad market index funds

00:08:28.060 | and ETFs in your portfolio.

00:08:30.660 | The three-fund portfolio, Taylor Laramore isn't here,

00:08:34.300 | but he'll be joining us tomorrow night at the dinner

00:08:37.300 | to say hello to everyone.

00:08:39.000 | Taylor's three-fund portfolio,

00:08:41.780 | when you look at it,

00:08:42.620 | is just the most elegantly simple creation

00:08:47.620 | where you have diversified U.S. equity exposure,

00:08:51.820 | so you're picking up more than 4,000 individual equities

00:08:56.020 | in a total stock market index fund,

00:08:58.380 | total international nearly 8,000 individual equities

00:09:01.940 | in the bond market, holy cow, 17,000 individual bonds.

00:09:06.940 | So it's a really well-diversified mix.

00:09:10.460 | I think that's one reason why many bogleheads use it

00:09:13.700 | as the baseline for their portfolios,

00:09:16.200 | though I would argue people in retirement

00:09:18.380 | would probably want to augment these holdings

00:09:21.180 | with at least some cash as well for a year like 2022.

00:09:25.460 | So if they need to take withdrawals,

00:09:27.120 | they can pull from the cash without having to disrupt

00:09:31.160 | declining stock and bond holdings.

00:09:33.780 | So conclusions when we reflect on diversification

00:09:36.780 | and how we want to think about it,

00:09:38.260 | I do think that diversification is an expression of humility,

00:09:42.900 | an expression of saying there are a lot of things

00:09:45.460 | I don't know about how this world could unfold,

00:09:49.140 | and so I'm going to build a portfolio

00:09:51.740 | that will help me fare reasonably well

00:09:54.320 | in any number of eventualities.

00:09:57.520 | So that diversification helps lower volatility,

00:10:00.420 | which makes it easier to stick with your plan,

00:10:02.700 | and I think you probably hear that idea

00:10:04.620 | of sticking with your plan again and again,

00:10:07.140 | but that's the name of the game.

00:10:08.860 | The most well-crafted portfolio isn't worth anything

00:10:13.140 | if someone can't stick with it,

00:10:15.020 | but building in diversification helps lower that volatility.

00:10:18.660 | It makes it more likely that you'll stick with your plan.

00:10:21.860 | It's essential across asset classes, across account types,

00:10:26.860 | but I think it's especially essential

00:10:30.040 | once you move into drawdown mode

00:10:32.360 | or as you get close to needing your funds in retirement

00:10:36.200 | or whatever goal that you're hoping to fund,

00:10:39.200 | it's important that you have assets

00:10:41.160 | that you can pull from at those times

00:10:44.640 | to ensure that you won't need to pull

00:10:47.080 | from depressed asset classes.

00:10:50.100 | And finally, it is possible to overdo diversification.

00:10:53.260 | I see this all the time,

00:10:55.020 | and the main issue with that diversification

00:10:58.760 | is that it can obscure the big picture with your portfolio.

00:11:02.520 | So less is more.

00:11:03.660 | As long as you've done the basic blocking and tackling

00:11:06.740 | of asset class diversification,

00:11:08.860 | intra-asset class diversification,

00:11:11.140 | account diversification, and timing diversification,

00:11:15.220 | that goes a long way to ensure

00:11:18.020 | that you have proper diversification.

00:11:20.880 | So I'll leave it right there, and we have a break.

00:11:24.540 | Thanks.

00:11:25.380 | (audience applauds)

00:11:28.380 | [BLANK_AUDIO]

Bogleheads® 2022 Conference – Bogleheads University – Principle 4: Diversify

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