The Myth of Portfolio Diversification

What Happens When Everyone is Wrong?

If everyone is telling you the same thing, but that thing is actually not true, how are you going to figure out that that one thing is actually hurting you? Take the Harvard or Yale Endowment. A lot of people look to this as the standard for successful investing. But one of the things I rail against that most people believe to be true is stock market portfolio diversification. You know the story. You should have some in large-cap, mid-cap, small-cap, some in bonds, some in the international, and some in commodities. The problem is that portfolio diversification promises you that your money will be protected on the downside when the market falls, crashes, or sells off. And that when the market is in a stable uptrend it will grow faster.

Even The “Disrupters” Follow the Herd

But if you actually look at the evidence, that is actually not true. What’s crazy is that even when you go to the industry disrupters like the “pick-of-the-month” newsletters or even people like Tony Robbins – THEY tell you to do the same thing. Even look at the Silicon Valley disrupters. They still believe in portfolio diversification, too. Go to Harvard and look at their allocation and you’ll see the same thing. Yale too. Portfolio diversification becomes something you can’t question. Look at the image below. Both Harvard and Yale diversify in very similar ways. In the ways that we’ve all been trained to diversify.

What Does the Evidence Say?

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But the evidence clearly says you shouldn’t invest in international stocks. Look at the chart below it shows nearly 20 years of data. It compares the World Index with the S&P 500. When the prices are going higher and to the right then international is beating the U.S. market. But if the prices are going lower and to the right then the U.S. market is beating the international market. So if you have been diversified between these two assets over the last 20 years, you have literally been driving with your foot on the break for two decades.

More important is that clearly over the past 10 years the U.S. stock market has been significantly outperforming the international markets. This is not an opinion or belief or thought. It’s clear hard data. But diversification is a sacred cow. With the diversification mindset, of course you’d have money exposed internationally and that would HURT you and your portfolio. Portfolio diversification is what everyone says to do. But that’s exactly the problem!

What About Whipsaws?

But there is one main thing people often say when this is brought up. They say – well you can’t know when to change over. But I say to you, rather than take this approach why not ask a simple question: What is a way I can mitigate whipsaws or a change in trend? And there are two clear answers. First dollar cost average out of one and into the other. You can even do this over a year or two. But the second and more impactful thing you can do is to use moving averages to minimize whipsaws. In the chart above there are no moving averages, but I include those in the research that my member’s get so that they know when to be in or out of the markets and can align their money to them.

And you know what? It’s ok if you’ve been diversifying. I mean that is what everyone, everywhere is telling you to do. It’s not your fault. But now you know. Portfolio diversification is a tax. Instead you want to align your money to the market. You want to look for assets that are trending up. The bottom line is that you want to know what the trend is. And finally you want to know what the probability of your money safely growing in an invest is. And guess what? Probability is a very easy thing to figure out in investing. At Fearless Wealth we ask and answer two questions. With these two questions you’ll know how probable it is that your money will grow in the stock market and you’ll know what part of the market is trending higher.

 

In Your Corner,

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RC Peck, CFP  

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