economist: Diversification does not work
Perhaps it should not be too surprising that, according to Merrill Lynch, over the past five years the Russell 2000 index of small American companies has a 94% correlation with the S&P 500, the main Wall Street index. More alarmingly, international stockmarkets have not offered any diversification either: they have shown a 95% correlation. Yet more startling are the figures showing that hedge funds have recorded a 94% link with shares. Even property has been following Wall Street 81% of the time.
March 11th, 2007 11:52pm
"Even property has been following Wall Street 81% of the time."
WTF? So that recession where property was skyrocketing and jobs were in the sh*tter. That was my imagination? Who comes up with this stuff.
>Russell 2000 index of small American companies has a 94% >correlation with the S&P 500, the main Wall Street index.
Both of those are just about as diversified as you can get. I'm sure you could have picked plenty of single stocks that performed well below S&P 500, so I'm not sure what their argument is. No one claims that diversitication of investments guarantees to safeguard you from any loss.
When everything's overvalues it all falls down simultaneously.
Perhaps China should spend more of its money on a space program. That seemed to have helped the US back in the 60's.
March 12th, 2007 10:49am
> WTF? So that recession where property was skyrocketing
> and jobs were in the sh*tter. That was my imagination?
I feel the same way. I read the phrasing to mean in the last 5 years. So yeah, maybe they only catch that one year '02 when the market was following and property (?) was rising.
> performed well below S&P 500, so I'm not sure what their > argument is. No one claims that diversitication of
> investments guarantees to safeguard you from any loss.
The argument is that a 90%+ correlation is quite high. They were hoping for more, I'd guess.
March 12th, 2007 12:09pm
I don't understand what the big deal of diversification is.
The more diversified you are, the closer you get to following world-wide average growth which means you've only succeeded in pegging exactly to rate of inflation. May as well just keep it in a savings account.
Choose one stock, choose a thousand stocks in an industry, choose the top performers in every industry, you're still just gambling.
Isn't it just a refuge of smaller risk takers?
Everything in moderation michael.
Think of it this way. You've got one stock that you expect to go up 25% a year. The risk, which we'll define as the standard deviation of the return, is 20%. Now, you like getting 25% a year on your money, but that risk makes you nervous. You're so nervous you're thinking about another stock that you expect to make 10% but the deviation has only been 1%.
Clever math guy comes along and points out that two stocks say a small cap and a large cap can both have 25% expected return and 20% risk. Put them together and you get 25% expected return and lower risk. ... How much lower risk? Well, the less correlated the two, the better.
March 12th, 2007 4:10pm
I hear you, zed, but this theory depends on being able to accurately quantify how risky something is, which is itself a bet, isn't it?
Oh yea. It's all the risk & return we think this stock will have in the future. It's a bet. But diversification on top of your bets, that's pure sensible math.
March 12th, 2007 4:57pm
I am quite sure it's better than saving account with which the bank invests in 'safe' items.
Rick, try writing better English
March 12th, 2007 5:15pm
I am with Michael B here.
Diversification is oversold.
In Russian roulette, betting on one number is risky. But what do you do if you bet on five numbers which are equally risky spending more? You are increasing the risk. Like people speculate when the mean invest, they can increase the risk rather than decrease when they say they diversify. They may not do intelligent diversification but use the term in their own sense and increase the cost and risk involved.
Rick, you are incorrect when you say it's always better than money being in the bank. If you have money in the bank and if inflation, the general CPI or more specifically your personal CPI, goes down, the value of the money in your bank increases. Assume also that the diversified basket of the stocks chosen goes down in value. This is not an unlikely situation.
Diversification means more transactions which increases your cost. If your portfolio goes down in value due to bad diversification, your safe money in the bank buys you more.
March 13th, 2007 10:27am
Well, all that said and done, I still stuff money into the S&P 500. Everyone else is doing it, what could go wrong?
It may go wrong or it may not. When there's a bear market, you have a lot of chances of losing the actual capital invested. In that case, there's no the return on the money to talk about. If it goes wrong, it does so for a lot of people too. So it may not feel as painful as when you are alone.
By reducing the costs, you can make the most of what the index can give. But people invest in a fund or even in a fund of funds and after all the routes it takes, it gets invested into the same index finally. So you pay sure money for the people who are no better than you. This is something that can clearly be avoided.
Even if it isn't bad, it's unlikely that it'll be great as everyone knows about it and hence can't be bought at a low price.
March 13th, 2007 1:03pm