VTSAX + VTIAX diversification

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
fire2031
Posts: 30
Joined: Tue Dec 03, 2013 10:30 pm

VTSAX + VTIAX diversification

Post by fire2031 »

One of the popular ways to diversify that I see advised online is to allocate stock assets between US Total Stock Market (e.g., VTSAX) and International Total Stock Market (e.g., VTIAX). In fact, the stocks in a Target Retirement Fund like VTIVX are allocated between VTSAX and VTIAX.

Yet, when I chart the 10-year data of VTSAX vs. VTIAX by going here:

https://investor.vanguard.com/mutual-fu ... nd-returns

I see strong a correlation between between them. They're up and down basically in synchrony.

Does allocating stock investments between domestic and international stocks still reduce volatility? How?

Thanks.
User avatar
grabiner
Advisory Board
Posts: 35307
Joined: Tue Feb 20, 2007 10:58 pm
Location: Columbia, MD

Re: VTSAX + VTIAX diversification

Post by grabiner »

Diversification does not require zero correlation (which would result from independent assets). When there is a correlation, there is less diversification benefit, but still nonzero.

Suppose that Fund A and Fund B each are equally likely to outperform or underperform benchmark X by 5%, and those deviations are independent. A 50/50 portfolio of the two has a 25% probability of underperforming X by 5%, a 25% probability of outperforming X by 5%, and a 50% probability of matching X. Thus it has less risk than either individual fund, and because of the way compounding works, it will have a slightly higher compound growth rate. (To see the benefit of risk reduction on compounding, note that two years of 10% gains compound to 21%, while 0% and 20% over two years give 20%.)

While the numbers may not match, this is the same logic as combining US and foreign stocks. If US and foreign stocks have the same expected return, then a portfolio combining the two will have that expected one-year return with less risk, and slightly higher compounded return.
Wiki David Grabiner
Post Reply