We
use Monte Carlo simulations to develop well-tempered portfolios
that can weather a variety of investment climates. Unless you
practice extreme diversification, you are taking too much risk
for the returns you are getting.
Pseudo-diversification
Imagine
that you are fortunate enough to own a core Dimensional Fund
portfolio like Dimensional Global Equity (DGEIX). At last count,
this fund owned 13,194 stocks from domestic, foreign developed
and emerging markets. Yet from our point of view, it is significantly
underdiversified.
How
can this be?
It
is underdiversified because domestic, foreign and emerging market
stocks are all highly correlated with each other. The intercorrelations
all hover in the 0.80 range. Just because a portfolio has a
bunch of pleasantly different-sounding names for its investments
does not mean that it is diversified. Diversification is not
a function of language -- it is a function of the actual behavior
of the components of your portfolio
You
can always diversify a global equity portfolio by loading it
up with bonds, but these also neutralize your performance. A
better option is to raise the level of diversification to where
you take maximum advantage of Modern Portfolio Theory. This
means including carefully selected real estate investment trusts,
commodities, utilities, regional banks, health care, consumer
staple, and individual country stocks.
Unless
these are represented in your portfolio at beyond a market-weighted
level, you are not getting the optimal return for the amount
of risk you are taking. Even if you hold a DFA portfolio elsewhere,
why not let Conservative Wealth Management LLC design a diversifying
portfolio around it so that you can take full advantage of the
portfolio diversification effects? Diversification is the only
free lunch in financial economics -- it's a shame that so many
smart investors settle for less than a full meal.
Tactical
Asset Allocation
In
addion to practicing extreme diversification, at Conservative
Wealth Management LLC, our target core asset allocation is not
static. We overweight asset classes that are undervalued relative
both to their long-term fundamentals as well as to each other,
while underweighting those that look pricier.
Tactical
asset allocation is Market
Timing in
practice....