Thoughts on portfolio diversification [2025]

Investing / Portfolios
130

For the record, I quoted from both of your paragraphs (as stated at the time I write this), but putting aside the he-said-this and I-said-that aside, I agree with your premise (well, that might be overstating what you wanted to state, but as a Papal Influencer, especially ahead of the Conclave, I like stating things in easily understandable language: passive is can be a fig leaf for actually active index investors that, well, actively hop between ETFs they like based on macro themes they embrace.

There, I said it.

131

I “underweigh” US in comparison to market cap because my regions are weighted by GDP.

I’d classify myself as a truely passive investor.

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132

I actually don’t think there is anything called truly passive approach.

I think it’s totally made up assumption on internet that totally passive = VT (most likely marketing from vanguard)

Totally passive can be anyone of the following-:

  • VOO or SPI or STOXX 600 only
  • MSCI world
  • MSCI ACWI

Maybe by totally passive people mean folks who make a diversified strategy (whatever that means) and set and forget .

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133

My problem with GDP-weighing is that when GDP grows, you increase your investment in public companies, even though that growth might have been driven solely by growth of private companies.

Whereas a solely market-cap driven weighing would increase investment only when the companies grow that you actually invest in.

134

Sir, in my book you are a *GDP size following market cap active investor".

You may still call yourself a passive investor, of course.

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135

Yeah. I’m not making a science out of it. My GDP is static from the beginning of my investing and not even the countries are weighted by GDP just the regions (north America, Europe, etc).

The point is, it’s still totally passive. Whatever is the definition of passive, I don’t think market weight should be a prerequisite.

136

The Perfect Passive Investor™, to me, invests in VT or similar. All-cap, all-world.

If someone diverges from that, they usually have their reasons. Diverging from market cap is pretty major, so I was interested how and why (US capped at 50%? Why not 48%? Why not 10%?) they’re doing it.

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137

What Is ‘Active Investing,’ Really?

Active investing means investing in funds whose portfolio managers select investments based on an independent assessment of their worth—essentially, trying to choose the most attractive investments. Generally speaking, the goal of active managers is to “beat the market,” or outperform certain standard benchmarks. For example, if you’re an active US equity investor, your goal may be to achieve better returns than the S&P 500 or Russell 3000.

What Is Passive Investing?

If you’re a passive investor, you wouldn’t undergo the process of assessing the virtue of any specific investment. Your goal would be to match the performance of certain market indexes rather than trying to outperform them. Passive managers simply seek to own all the stocks in a given market index, in the proportion they are held in that index. Because active investing is generally more expensive (you need to pay research analysts and portfolio managers, as well as additional costs due to more frequent trading), many active managers fail to beat the index after accounting for expenses—consequently, passive investing has often outperformed active because of its lower fees.

A New Take on the Active vs. Passive Investing Debate | Morgan Stanley

138

Strongly considering shifting my UCITS VOO equivalent in USD to cash if ATH is reached again → waiting it out for ~3-6 months and then splitting 1/3 to URPO (or TQQQ) and 2/3 to SCHD. Then rebalance quarterly. VWRL will continue to be ~60% of the portfolio and all contributions will continue to go there. Dividends will continue to be funneled to BRK.

May need to learn to do the DA-1 thing after all :wink:

Feel free to :sweat_smile:

Edit: actually did it with 5% profit from the cost basis.

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139

VermögensZentrum has a new article about bonds and that they are an important part of every portfolio.

What caught my eye was this chart:

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In my eyes, it is deceptive. It makes it look like stocks and bonds offer about the same returns, with stocks being much more volatile. It also conveniently ignores the big drawdown bonds suffered in 2022.

I whipped up some charts with time periods of 5 and 19 years, which offer a much more complete picture:

spi-vs-sbi-5y
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spi-vs-sbi-19y
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140

Bonds are mainly volatility dampers as they reduce your equity exposure. Some amount of negative correlation helps in most bear markets as well, with a small positive expected real return over the long run.

It makes people stay the course, as most people can’t handle 100% equity. I do think they are important to have for the average risk averse investor.

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141

I think this article from Pictet is more complete in its analysis.
From 1926 to 2024, following are REAL returns

  • Swiss equities 5.6%
  • Swiss bonds 2.1%

Personally I think it’s quite normal that equities come with higher returns because investor takes most of the risk as well. With bonds the risk is also there but it’s lower risk and hence lower returns.

The challenge is that there is always a difference between what’s normal return and what a particular person would experience. This depends a lot on when they start investing.

Extract from the Pictet article

As previously noted, the average annualised return (geometric mean) for Swiss equities and bonds (in CHF) over the past 99 years is 7.7% and 4.0% respectively in nominal terms. Due to the sell-off in both asset classes in 2022, these figures are somewhat lower than in July 1998, when we first published our long-term return analysis. The average annual return over the period from 1926 to 1998 was 8.6% for equities and 4.6% for bonds.

The resurgence of inflation after Covid-19 makes that it more important than ever to pay attention to real returns (which take into account the erosion in the value of money). In real terms, the return from Swiss equities averaged 5.6% between 1926 and 2024, only slightly down from the 6.0% figure for the period between 1926 and 1998. The variation is smaller for Swiss bonds, which made an average annualized 10-year real return of 2.1% up to the end of 2024, the same return as at the end of 1998. Again, these figures show that equities provide better real returns than bonds over the long run.

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142

this line basically describes why i decided to diversify my diversifiers. i don’t see how any single diversifier provides an “ideal” mix of return/volatility/correlation/cost. using some very rough numbers: let’s say equities make ~5% in real chf over relevant periods, while diversifiers on average make ~1.5%. but that’s with different periodical outcomes for a) returns (e.g. ~0-3%) and b) correlations/volatility (necessary to actually benefit from diversification, plus adding rebalancing benefits) due to different causes for bear markets.

why would i bet on a single diversifier if they’re all not great (on a standalone basis, in portfolio context)? bonds only doesn’t seem that great to me in particular, as diversifiers leaning towards some inflation protection could be attractive when a) monetary policy favors inflation and b) deflation is much less of an issue in retirement.

tell me about the flaws here :slight_smile:

143

That‘s the correct thinking actually.

Also bonds mostly serve as “positive ballast”.

Just that you cannot sell it to most people and make them stick to different things.

People barely understand stocks and bonds. But those are the two most basic assets and at least everyone is in the same boat, when they do bad.

I‘m arguing mostly from the psychological point of view.
It‘s going to be hard for people to manage multiple assets and if their fancy diversifier underperforms, and they don‘t know why.

As said majority of people should stick to stocks and bonds, maybe some small amount of gold/commodities tops.

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144

True

Most people (DIY) don’t know much about asset allocation and multi asset strategies. So I think educating them with 2-asset strategy is a good start.

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145

You can change almost any return comparison by picking different starting points.

However, this sword cuts both ways: if you want to invest today, you’re also picking a starting point … might be the one where blue outperforms red or vice versa or both remain flat.

(Given long enough time frames we all know of course that equities outperform bonds)*

* At least for the (very few) markets/countries I am familiar with.

Narrator (aka Chat-GPT) puts Goofy to shame:

"Yes, there have been markets and time periods where bonds outperformed equities over 5 years or more, especially during times of:

  • Severe equity underperformance (e.g., crashes, lost decades),
  • Falling interest rates (which boost bond prices),
  • Or deflationary environments.

Examples:

:japan: Japan – The “Lost Decades” (1990s–present)

After the stock market crash in 1989, Japanese equities (e.g., the Nikkei 225) stagnated or declined for decades, while Japanese government bonds (JGBs) delivered positive returns—albeit modest. Over many 5- and even 10-year periods, bonds outperformed equities.

:united_states: United States – 2000–2010 (“Lost Decade”)

  • The S&P 500 delivered negative real returns over this period.
  • Meanwhile, U.S. Treasuries and investment-grade bonds performed well, especially during the 2008 financial crisis, when equity markets tanked and investors fled to bonds.

:european_union: Europe – Various Sovereign Debt Crises

In the Eurozone periphery (e.g., Greece, Italy) during the 2010s, equity markets suffered, while core government bonds (like German bunds) provided better returns during flight-to-safety phases.

:classical_building: Emerging Markets During Currency Crises

In some emerging markets (e.g., Argentina, Russia, Turkey during specific crises), equities collapsed in local or USD terms, while hard currency bonds (like USD-denominated sovereign debt) outperformed over multi-year stretches.

So yes, equities outperform bonds over the very long run (30–50 years) in most markets, but over 5–10 year horizons, especially during crises, bonds can and do outperform."

146

I get that, my point was I thought the chart in the article was deceptive by only showing a steady climb. No talk of “bonds can have their bad moments too” in the article either.

Sure I can show whatever I want by picking the “right” start and end point. The point of my first chart was to include the (for bonds) severe drawdown that was ignored in the VZ article, and of the second to show the max history through publicly available historic data from SIX.

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147

All clear.

(My reply to yours wasn’t a criticism, just an amendment.)

148

Every time I looked into bond trading as opposed to buying and holding single bonds (not even bond funds) I ended up feeling it’s a lot more speculative and complex than stocks, would you agree?

149

Do you mean like bond arbitrage stuff?