CM in MA

Portfolio Planning and the Lost Decade

Geoff--thanks for the link to the DALBAR study. I gave it a quick look, but will read it in detail.

I was in the TSP while in the military. I think it is a great program. Keeps things simple. Many 401k/403b plans could (and do) do worse than use the TSP as a model.

Portfolio Planning and the Lost Decade

ok, I give up: I typed "reallocating" correctly twice and both times it changed to reallocati...

Portfolio Planning and the Lost Decade

above should have read: "folks were rebalancing/reallocati... too frequently"

Portfolio Planning and the Lost Decade

Geoff--yeah, don't know if the equal weighted portfolio would be a good benchmark or not. Seems to me, though, the only other choice would be to lock in the original P20 allocation as the benchmark for subsequent changes. My rationale for that is the need to isolate the effects of future reallocation decisions. After all, once the portfolio strays from equal weighting, it becomes an exercise in index/sector timing and rotation.

On a related topic, are you familiar with the government's Thrift Savings Plan? www.tsp.gov The reason I ask is that it is potentially a giant laboratory to study investor behavior vis-a-vis asset allocation decisions and results. As of Nov 2007, there were 3.8 million participants with $231.5 billion in assets. The TSP provides three asset class choices: equities (large-cap, small/mid cap, international), bonds, cash. There are some recently introduced lifecycle funds consisting of these choices. Awhile back, there was some discussion of including other asset classes, but that has not happened yet. For all intent and purposes, reallocation is cost-free, so that removes a factor from the decision process. It is interesting that limits were recently established for interfund transfers--folks were rebalancing/reallocati... too frequently and driving up plan costs for other participants. So, even with just five choices, it would seem there were some people attempting to time the swings in the markets rather than using some basic asset allocation to smooth the long-term ride. Anyway, I couldn't say whether the government has ever studied the results plan participants have achieved, or whether they'd even be interested in doing so. However, it strikes me as a well-controlled experiment in investor behavior.

Portfolio Planning and the Lost Decade

Geoff--no vitriol from me. I don't find your approach to diversification at all objectionable. Sure, diversifying beyond the S&P 500 (or any other index) makes sense, but doing so via funds that represent other indexes (either market or sector) means that there are, at the very least, four certainties: 1) the portfolio will never outperform the leading index or sector, 2) the portfolio will never underperform the trailing index or sector, 3) the portfolio will experience less volatility than the most volatile index or sector, and 4) the portfolio will experience more volatility than the least volatile index or sector. Again, there is nothing wrong with damping volatility in this manner, so long as that is the objective within the investing universe the portfolio encompasses. It does not, and cannot, guarantee positive returns over any time period be it short, intermediate or long. Moreover, taking the approach you describe means that it is no longer valid to look at portfolio return against the S&P 500. The returns would need to be weighed against an equal weighted blend of the portfolio constituents to determine the advantage of the weightings found in P20.

Berkshire, or more specifically Buffett, doesn't look at risk premiums or benchmarks. Nor, I suspect, does Buffett care about diversification as it relates to returns during any time period. He simply seeks to buy good companies at reasonable prices. The reasonable price approach addresses the risk you are trying to reduce via diversification because any index/sector approach is not a business oriented approach to investing. From a business perspective, there is no inherent margin of safety in buying an index or sector fund. It is comparing apples to oranges. Whatever the measure of diversification within Berkshire's portfolio turns out to be, Buffett would likely consider the measure a curiosity at best.

Portfolio Planning and the Lost Decade

Geoff--an interesting article as far as diversification goes. One reminder to ETFers, though, check the portfolio in the ETFs for overlap. IGE and IVV (23% of the portfolio) have 20% overlap in their top 10 holdings. To be fair, P20 doesn't appear to have a great deal of overlap overall.

In down (and flat) markets, the wonders of diversification are always trotted out. Not that any of us, myself certainly included, can lay claim to the mantle of Warren Buffett, but he had this to say about diversification: Diversification serves as protection against ignorance. If you want to make sure that nothing bad happens to you relative to the market, you should own everything. There is nothing wrong with that. It’s a perfectly sound approach for somebody who doesn’t know how to analyze businesses."

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