Weekend Reading – Does diversification really matter?
Hey Everyone,
Welcome to a new, fresh Weekend Reading edition, questionning the merits of diversification in practice.
Does diversification really matter?
Some thoughts on that in a bit.
First up, a few reminders of some popular posts on the site:
Due to the behavioural factors involved, investing remains very different from other things in our lives. That includes leaving things well alone for the most part…
“Like a bar of soap, the more I touch the portfolio the smaller it could get…”
CNQ stock has been on a tear this year and I’m thankful I own this stock in my portfolio – as oil and gas prices move higher.
Weekend Reading – Does diversification really matter?
It should and does but in practice it doesn’t matter to some of the best investors of our time.
Let’s start with the theory, first.
Diversification is the approach of spreading your investments around so that your exposure to any one type of asset (or stock) is limited.
A reminder one of the keys to successful investing, is learning how to balance your personal mix of financial objectives with investing risk against your investing time horizon.
There are risks incurred with investing either too conservatively or aggressively:
- Invest too conservatively for too long and you have two key problems to overcome:
- the growth rate of your investments won’t keep pace with inflation (see today!), and
- your investments may not grow to an amount you need/you want.
- Invest too aggressively as you age, when you’re older, and you could introduce other problems:
- your savings/investments are unnecessarily exposed to stock market volatility, and
- your investments have less runway/time to recover.
A reminder I highlighted these issues in my recent post below:
So, a great way to diversify is to consider spreading your assets across different assets classes, your mix of stocks, bonds and cash although I’ll throw in real estate there too.
There are four key reasons to diversify:
- Not all types of investments perform well at the same time.
- Different types of investments can be affected differently by factors such as interest rates, exchange rates and inflation rates.
- Diversification can help you build a portfolio whose risk is smaller than the combined risks of the individual securities.
- If your portfolio is not diversified, it will be unnecessarily risky. You will not earn a higher average return for accepting the unnecessary risk.
Let’s recap some components and features of a diversified investment portfolio before we get into some real-life results.
- Domestic stocks: because stocks are generally more volatile near-term than other types of assets, you are compensated for that investment risk for higher, longer-term growth potential.
- Bonds: bonds are now back into favour given they provide regular interest income and are generally considered to be less volatile near-term than stocks. Bonds can also act as a cushion or “parachute” against stocks when they fall in price. Because bonds offer more near-term safety, bonds don’t offer returns as high as stocks over the long-term.
- Cash/short-term investments: I’ve lumped cash with short-term investments like money market funds for the purposes of being conservative with returns but also the high-accessibility feature to your money pretty much on demand. I would therefore put some cash alternative ETFs in this category as well – assets I own.
- International stocks: again, because stocks are generally more volatile near-term than other types of assets, you are compensated for that investment risk but beyond that, international stocks can and often do perform differently over time. We’ll see that below. Foreign stocks are not however guaranteed to perform better, “it depends”. In fact, over some investing periods, some international stocks simply don’t perform better.
Here is a five-year chart comparing low-cost VFV for U.S. stocks (international for us Canadians), vs. XIU for Canadian domestic stocks, vs. VIU for ex-Canada/ex-U.S. stocks:
Source support: Portfolio Visualizer
The results simply show VIU (investing beyond North America) is a laggard despite some experts I’ve heard over the years praising the merits of heavy ex-North American investing over the years.
And if you think 5-years is too short, fine. I do too. Ha.
Consider the results of highly touted VXUS by some financial experts. Annualized returns just north of 4% for over a decade. Not great, but, in the name of diversification it works. FYI – VXUS includes Canadian stocks too.
Source: Vanguard
Are these experts wrong in their diversification advocacy?
No. Diversification can be very wise. It works.
It is touted because financial advisors, money managers and talking heads on YouTube or TV can’t predict the future either.
In theory, diversification enables you to reduce the risk of your portfolio without sacrificing potential returns. So, in practice, a reminder that diversification offers potential results by spreading your risk around. Once your portfolio has been fully diversified, you have to take on additional risk to earn a higher potential return on your portfolio.
Diversification works because asset prices are not perfectly in sync. Diversification becomes less effective in extreme market conditions. When something unexpected occurs, like a crash or a pandemic, markets can become illiquid and the prices of most investments drop. Depending upon what you are invested in, your portfolio might not be saved. See 2022 when stocks and bonds, in a traditional balanced portfolio, both got hammered. A reminder the typical 60% stock/40% bond portfolio declined about 16% in 2022—a painful period for balanced investors that continues to still raise doubts about the viability of this strategy…but any balanced portfolio should be more than fine long-term.
The real question to answer for every investor I believe is to your own thinking and decision-making – assess to what extent he/she should diversify their portfolios. Your answer will depend on your personal goals, risk tolerance, and preferred investment strategies.
The greatest investor of our time, despite what he preaches, does his own thinking and does not practice diversification.
Far from it.
“By periodically investing in an index fund, for example, the know-nothing investor can actually out-perform most investment professionals. Paradoxically, when ‘dumb’ money acknowledges its limitations, it ceases to be dumb.” – Source: Berkshire Hathaway shareholder letter 1993.
And…
“In my view, for most people, the best thing to do is to own the S&P 500 index fund. People will try and sell you other things because there’s more money in it for them if they do.” – Source: Berkshire Hathaway Annual Shareholder Meeting 2020, courtesy of CNBC.
Here is a look at Warren Buffett’s portfolio today. You can always track it yourself. Do you see diversification in practice?
Weekend Reading – Does diversification really matter?
Personally, I embrace the merits of diversification but not in the form of a balanced 60/40 stock/bond portfolio.
I acknowledge I have no investing clue what the future might hold. I really don’t. So, I don’t take many concentrated bets.
I do however hold a number of Canadian (and some U.S.) individual stocks for income and growth.
I’ve unbundled my Canadian portfolio for over 10-years now. It’s just my preferred way to invest in Canada.
I own a few U.S. stocks at this time but I’m more in favour to invest beyond Canada in low-cost ETFs of my choosing that provide extra diversification benefits.
This “hybrid approach” I’ve coined well over a decade ago works for me. I demonstrate the progress of my approach, good, bad or indifferent every month. We’re all different as investors…I welcome all forms of investing on this site and always have. I don’t believe in cookie cutter solutions for everyone.
In an older post about hybrid investing from 2012:
“Including the small addition to my portfolio last month my dividend income increased when compared to May and I’m happy to see I’m on target to earn about $6,000 in dividend income this calendar year.”
Well, here is where we are now…
We are slowly realizing our goals. That’s all that matters for you too. I doubt I will change my overall investing approach but who really knows. I’ll keep you posted if I do… 🙂
When it comes to diversification, the approach has merit. The theory is excellent. The results in real-life can be different.
More Weekend Reading…
I’ve followed some news on Twitter/X this week about some advisors downplaying the importance of cash. To each their own.
A fair analysis of having cash in your portfolio. https://t.co/mSGsD8pVOW
— Martin Pelletier (@MPelletierCIO) September 1, 2023
From Morningstar:
“And it’s always important to keep some cash on hand to cover unexpected emergencies, such as job loss, car repair, appliance replacement, and so on. Most financial advisors recommend keeping at least six to 12 months’ worth of living expenses in cash as an emergency fund—even if you don’t end up spending it right away.”
And from Morgan Housel:
“We do it because cash is the oxygen of independence, and – more importantly – we never want to be forced to sell the stocks we own.”
Tawcan (Bob Lai) completed his portfolio review. It seems he might consolidate his holdings over time for simplicity.
Eat, Sleep, Breathe FI offerred some thoughts for women related to how to protect yourself financially.
Rob Carrick highlights some stats (subscription) that demontrate women are doing some savvy work with their TFSAs.
Mortgage guru Ron Butler says: “Yeah, it’s REALLY Frigging Bad” when it comes to the housing crisis, for younger Canadians. An entertaining watch but also a reality check for some…
Save, Invest, Prosper!
As always, there are Deals to be had on that page – always good to save, invest and earn more where you can, staying frugal or otherwise. 🙂
Need help with any retirement income drawdown order or projections for your retirement? Contact me here over the summer for some low-cost solutions.
Enjoy your weekend,
Mark
Mark
My name is Mark Seed - the founder, editor and owner of My Own Advisor. As my own DIY financial advisor, I'm looking to start semi-retirement soon, sooner than most. Find out how, what I did, and what you can learn to tailor your own financial independence path. Join the newsletter read by thousands each day, always FREE.
We are in the same situation as Howard. Dividends from RRIFs and Unregistered and small pension cover all expenses. and spending a lot more on travel and golf than ever before. Still not drawing OAS or CPP. And there are still surpluses every month without touching dividends from TFSAs.
One year cash on hand of say 70,000, is 3,500 in missed dividends, That could pay for a couple of appliances or other emergency. We will continue to rely on our LOC if we ever need more cash. I do leave a couple of thousand in the chequing account just so my spouse feels safer.
As to diversification, very over rated for Canadian dividend investors.
“One year cash on hand of say 70,000, is 3,500 in missed dividends”
Not to be argumentative, but a one year Term deposit at 5.20% is 3,640 to replace those missed dividends with no risk.
https://www.happysavings.ca/products/terms/one-year-terms/
Not to be argumentative, everyone needs to do what they feel comfortable with.
A term deposit is not available without penalty until the end of the term, ok 3 months on this one. GIC also is locked in for the term. In three months I can pay for any emergency with dividends. And you argument has gotten much better since interest rates have been rising. But for almost 20 years cash has made very little, and I’m still stuck in the past when it comes to cash. Keep doing what works.
“ok 3 months on this one.”
That’s one of the reasons we have split our holdings of these funds into six (three terms each). We are never more than two weeks away from a quarterly anniversary. The *point* was that “cash” does not have to attain a zero rate of return.
I too used to be almost no cash (all equities) at one time. Times, attitudes, products, rates, markets, pandemics, wars, governments, tax rates, health conditions, etc etc etc, change. YMMV.
Yes, the current interest rates do indeed put a different slant on the cash or equities question, in the short-term at least. Since July, and until November 30th, I’m earning 5.5% in my Tangerine savings accounts; no lock-in period or minimum deposit. My wife didn’t get the same offer.
“I’m earning 5.5% in my Tangerine savings accounts”
That’s a great rate, *and* that time frame ain’t bad for a relatively smooth transition into TFSA season. I’ve seen lots of people talking about Tangerine rates but I’m just too lazy to open more accounts and move stuff around to another provider.
Very good rate. Higher interest savings accounts, GICs and cash ETFs are really good options now for anyone these days; for diversification benefits beyond just stocks.
That’s a strong rate for sure, even if only temporary until November. Any plans for keeping cash savings beyond that?
Mark
Yes, in conjunction with our dividend income, we have a rolling five-years worth of fixed income, comprising 50% cash/GICs and 50% bonds. I don’t particularly like having our money tied up in these lower growth assets, but it pretty much guarantees that we’ll arrive at our intended destination as planned.
It’s a very different game once you enter the decumulation phase. It was a three-year internal tug of war to arrive at the five-year safety net, and it feels just about right. It’s worth noting that the fixed income is used to top up the dividends to our required spend. I adjust the expected dividends down by 10% just in case they take a hit.
Ya, I bet! I hope to enter some form of decumulation in the coming years…at least a bit. No point in not spending from the portfolio.
As mentioned, I think as long as you are meeting your needs, and managing risk, good on you!
I’m with you, as always, very personal stuff.
I know some folks very close to 100% equities, meaning, barely any cash beyond chequing or saving accounts.
I know others that have enough GICs/cash to cover 6-7 years of annual expenses if needed as to never touch their stocks/equities. Obviously, they are far from 100% stocks/equities in their portfolios.
I will likely, in full retirement in the coming decade (?), land somewhere in the middle. There are opportunity costs with too much cash but with GIC rates now north of 5%, hard to see why some retirees might not have a little bit of that.
Mark
Definitely opportunity costs associated with too much cash, GICs or fixed income when compared to investing in stocks long-term. I do personally “feel better” knowing we are getting closer to having 1-years’ worth of key expenses saved up to start semi-retirement with in the coming few years.
I’ll keep you and others posted on my thoughts and plans – good, bad, or indifferent! 😉
Mark
Unlike actual life, we can have more than one financial life. We can bet big on one stock, crypto, or country, and crash and burn, lose everything and start again. However, on each occasion we do this, we lose something we can’t get back, time! Eventually, it’s all gone, and there’s nothing we can do about it. So, for me, diversification is the (financial) life saver. I don’t see any phenomenal wins worthy of a blog post, but I get there in the end. I realized early on that the markets are like a roller coaster, and as we go up and down on what can be a very scary ride, there is nothing I can do to control it. Diversification just smooths out the ups and the downs, but at least I get off the ride alive, in all senses of the word.
I hear ya, Bob. I’m about hitting singles now vs. hoping for a home run. I don’t need the latter to sustain some semi-retirement dreams.
I liked your comment about smoothing out the ride. 🙂
Have a great long weekend,
Mark
Hi Mark,
Re: Warren Buffett’s stock portfolio (shown above) vs An Equal weighting of his stock portfolio vs BRK.A vs VFV.TO annualized CAGR performance for period Jan 2018 thru Jul 2023
I did a back test Performance Summary of the above over the same period you measured in the article. In order for the back test to be carried out I had to adjust WB’s portfolio stock content percentages slightly so the list added up to 100%.
The CAGR performances are shown below:
Warren Buffett’s stock portfolio – Portfolio 1 = CAGR 24.25%
Equal weighting of Warren Buffett’s stock portfolio – Portfolio 2 = CAGR 12.16%
Berkshire Hathaway Inc Class A (BRK.A) – Portfolio 3 = CAGR 11.09%
Vanguard S&P 500 Index ETF (VFV.TO) = CAGR 12.66%
I don’t understand how Buffett’s portfolio could have more than doubled his BRK.A stock in performance. I realize he would have had some turnover in his portfolio contents over the period but I highly doubt it would have resulted in such a wide spread in results. FYI, I wanted to cut and paste the back test table & graph into this comment but was unable to. If you like I can email a copy to you, or you could run the calculation yourself.
Interesting results…thanks for sharing that!
I don’t have a way to attach files in comments but links to files can work.
The reality is: Buffett, despite what he says, does not practice lots of diversification. Apple, cash and a few other stocks. That’s essentially it. He’s very, very, very good a making some concentrated bets! 🙂
Mark
I think diversification is more important for collective investors than individual ones. An individual investor doesn’t have the requirement to pay an income year after year during the accumulation phase. In the decumulation phase, dividends can be used and no asset needs to be sold (except in a RRIF context where they don’t cover minimal withdrawal).
A collective investor, such as CPP in Canada and Social Security in the US (also applies to insurance companies portfolios), has annual payments to do and must have the corresponding liquidity.
Also, the investment horizon of an individual investor is finite (70-80 years theoretical max) while for collective investors it’s (almost) infinite.
I’m not sure what you mean by “a collective investor” but I believe diversification has merit for many DIY investors given nobody can predict the financial future. I simply choose to own some individual stocks + ETFs. Your mileage may vary. 🙂
I mean collective as opposed to individual. CPP invests for all Canadians, with very long term objectives (> 100 years). You and I invest for ourselves, with our lifespan (and decumulation duration) objectives. Also, there is a phase where we are accumulating and don’t need immediate access to liquidity. That phase is absent for collective investors.
I hope it’s clearer now.
I thought so, wanted to check. re: CPP.
Interesting…in that some individual investors could take on more risk for potential return since CPP is less risky/will be viable for another 75+ years.
Do you favour some concentration in your portfolio?
Mark
Indeed, regarding CPP, a lot of retirees use it as the bond portion of their portfolio.
I try to keep each holdings to a maximum of 5% of my portfolio when accumulating but I let my winners run. For example, Metro (MRU) represented 4% of the portfolio 23 years ago (didn’t buy more afterward) and now it reaches 11%.
The same thing happened with Warren Buffet’s portfolio. His 10% (more?) position in AAPL just increased organically.
“regarding CPP, a lot of retirees use it as the bond portion of their portfolio.”
Do they also consider the implications of the survivor/death benefits of the CPP in the event it is a couple? One should also consider the ramifications on a DB work pension as well. Not all are equal and it behooves one to be cognizant of survivor issues. Just food for thought.
Well put. We (my wife and I) have factored in survivorship concerns into our plans for sure. Makes sense.
Mark
Good on you!
I also like Ben’s procedure to factor in a “what if” reduction in dividend earnings. Everything I do is done with survivor benefits in mind.
Yes, but at some point having 50% of your stock portfolio (Buffett) in one stock is not wise. Who I am to argue with his approach though?? 🙂
Mark
“Does diversification really matter?”
Like most specific investing questions, my answer is likely to be “I don’t know” or “it depends”. I doubt there is a definite correct answer.
As to cash on hand. Again, need a better understanding of the situation and some clearer definitions first. Is a 1-year cashable GIC earning ~5% considered cash on hand? Is a HISA earning 4.55% in an investment account cash on hand? Or are we just speaking about a pure chequeing or “savings” account earning nothing or next to nothing?
In any event I hope I would never tell anyone they have too much or not enough cash on hand. I’d much rather say this is what we do (we have too much “cash”) and why we do it. People can hopefully make their own decisions once they have the proper information.
I think the best answer to this question is in hindsight. Some folks have gotten very wealthy making big bets on just one or a few stocks but I’m not sure I could invest that way.
The probability of having any one investor having “too much cash” is slim to none. Just my thoughts. 🙂
Have a great weekend and thanks for your comment.
Mark
I cannot speak for them, but you ask a very important question for couples for which CPP and OAS represent a large part of their income. It can be quite problematic if one partner dies early in retirement.
For my couple, CPP and OAS were ignored in our retirement calculations. If taken at 65, CPP + OAS would represent less than 10% of our income. Since our dividends grow faster than the CPP/OAS indexation, that percentage would only decrease with age, even if starting at 70.
Yes, portfolio survivorship/portfolio longevity are important considerations for couples too! Singles have more of a challenge.
As to having cash on hand. It is nice to have cash on hand when the markets are slumping. It is also nice to be almost fully invested when the markets are on an upswing. Some call it market timing. No one gets that right all the time. So pick you flavour, all in or hold back, as you survey your market makeup.
As to cash on hand for general living expenses, that is completely different. You shouldn’t be running to the bank, so to say, every time you incur an unforeseen expense. There should be enough cash or immediately cashable securities (without incurring a loss) to cover your needs within a week of incurring them. In this case cash on hand is much more positive.
RICARDO
Yup. I don’t agree with keeping cash for the sake of keeping cash. There needs to be a personal reason. Could be near-term spending, could be risk management, could be sleep-at-night emotional factors, could be the need/desire to deploy the money for equities, could be all of these things. Nothing right or wrong about it. Just trade-offs IMO.
I personally side with the Morningstar folks, etc. that suggest about a year or so of cash/equivalent, liquid cash to cover 1-years’ worth of lifestyles expenses just in case or to tackle any major financial emergency. That portfolio cash % might not work for some but I/we feel it works for us.
I appreciate your thoughts!
Mark
BUDGET – BUDGET – BUDGET!
I typically run close to 1/2 year in cash on hand.
Then I get the monthly government stipends. (RRQ, OAS, CPP and small company pension) which usually can cover the monthly expenses or pretty close to it. After that there are the mandatory amounts to withdraw from the LIF & RIF which permit me to 1) contribute to my TFSA 2) enjoy my like to do things and 3) re-invest any left over in to a non-registered investment account.
I do not take in to account any dividends that the TFSA and non-registered accounts generate, They usually get re-invested. However they are, so to say, available cash every month if I go on a spending spree. LOL
Aside from re-investing the funds, it has been several years that I do not need any “extra” cash.
So, as to my “budgeting” title. The best thing yo can do is know your living needs. Do you have enough Money to cover that? And then move in to your desires to put a smile on your face.
Figure out how much you need and where the dinaro is coming from. Hopefully you will have more dinaro coming in than what is going out.
RICARDO
Couldn’t agree more with the living with your means, know your living needs.
I’m not too concerned about readers on this site – there are some very savvy readers/investors of this site. I worry about the masses who might lact some basic saving and investing skills, or folks listening to too much media noise – instead of following established investors that have been there and done that. Those folks are the best teachers. Real people doing amazing investing things. I’ve learned a bunch from some readers of my site. I just hope to pay some of it forward…
Have a great weekend,
Mark
We have only been retired for 3 years and there have been many trips and travel expenses. Fortunately our income (pension, CCP, RRIF Dividends & dividends from two TFSAs) have covered it. I do have a secured personal line of credit which i would use in case of emergencies as opposed to keeping a lot of cash earning no income. Hopefully we avoid any emergencies during these high interest days, but if we do it can be paid off with excess dividend income in short order. We are 100% in dividend paying stocks and they are blue chip safe utilities , banks, telcos and pipelines, so pretty safe. If they have problems then we probably have bigger things to worry about than cash.
I think having an LOC as a back-up or back-ups is smart. Nothing wrong with that for major emergencies. I just feel safer to have some cash.
If pension + CPP + RRIF + TFSA income covers all your expenses and then some, you are in a fine place since you don’t even have OAS there.
Congrats, Howard!
Mark