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Controversial definition

The current page (as of July 26, 2019) presents a controversial definition of diversification which can be misleading for Bogleheads members. Selecting asset subclasses with the objective of increasing risk-adjusted returns is a technique that effectively concentrates a portfolio into sub-markets.

When financial authors discuss broad diversification, they use the traditional meaning of diversification that is about spreading one's money broadly across a market based on (float-adjusted) market capitalization (not equal-weighted across securities for obvious arithmetic reasons).

More importantly, the fourth principle ("Diversify") of the Bogleheads investment philosophy uses the traditional meaning of diversification: "Rather than trying to pick the specific securities or sectors of the market (US stocks, international stocks, and US bonds) that will outperform in the future, Bogleheads buy funds that are widely diversified, or even approximate the whole market. This guarantees they will receive the average return of all investors. Being average sounds bad, but it is actually a great thing."

The proper way associate the technique for asset subclass selection in the hope of increasing risk-adjusted returns with the word diversification would be to say "diversify across sources of returns" to avoid misleading readers.

I suggest putting a LARGE WARNING at this point on this page, until it is rewritten to present both definitions of diversification:

  • Main definition: Broad diversification (generally accepted, based on mathematical principles like William Sharpe's The Arithmetic of Active Management article).
  • Alternate definition: Diversification across sources of returns (controversial due to its reliance on statistical studies of historical return data of asset subclasses). It should be accompanied with a "Criticism" subsection which provides the opposing view that this effectively concentrates a portfolio into potentially tiny parts of markets.

--longinvest 13:05, 26 July 2019 (UTC)

I have added {{POV}} instead of {{Controversial}} as the content is accurate, but biased against the definitions used in the forum. The page is under discussion in Bogleheads® forum topic: De-Risking and Diversification aren't the same thing.
--LadyGeek 13:33, 26 July 2019 (UTC)

Response by longinvest

To help with the "Criticism" section of the controversial definition, here's a citation from William Sharpe's Market Portfolio:

"Someone once said that if you torture a body of data long enough, it will eventually confess to something. This is especially true of financial data. We now have massive amounts of information on the characteristics and returns of hundreds of thousands of securities over many years as well as computers and programs able to determine the returns over time from myriad investment approaches. Not surprisingly, by testing thousands if not millions of portfolio management systems it is possible to find one or more that would have produced superior, or even spectacular results. Many investment analysts, having discovered such systems, find it impossible to resist the temptation to create a mutual fund, exchange-traded fund or investment advisory practice using one of them, with documents showing “backtests” indicating its superiority in the past.

One skeptic of such approaches famously said that he had never met a backtest in such a document that he didn't like. Another said that if someone brought an investment product to market with a backtest showing that it would have performed poorly in the past he might invest in it, just to reward candor.

Financial history is replete with examples of cases in which an investment approach with superior past performance fails to “beat the market” in the future. In some cases, this may have been due to a focus on “noise” in a body of historic data. In others, is may be a change in market prices caused by the realization by sophisticated investors that some security prices were inappropriate in the past, resulting in corrections leading to more appropriate valuations.

In any event, it pays to be very skeptical indeed of schemes that purport to be able to “beat the market”." --longinvest 13:51, 26 July 2019 (UTC)

Response by vineviz

I'm not sure I understand what the bias is alleged to be. Contra to longinvest, the current page content doesn't contain the phrases "asset", "asset class", "asset subclasses", or "risk-adjusted returns". Currently, the content of the page is exactly three sentences and each one is sourced.

The primary definition comes straight from a textbook on modern portfolio theory, is congruent with the definition used in virtually all such textbooks, and is entirely consistent with the presentation of the Bogleheads® investment philosophy of "Diversify" ("...Bogleheads buy funds that are widely diversified, or even approximate the whole market"). A total stock market fund is "widely diversified" because it follows the process laid out on this page: it "combin(es) securities with less-than-perfectly-positive correlation in order to reduce the overall risk of the portfolio".

I take the fundamental Wiki principles very seriously (i.e. no POV, no original research, etc.), and I don't see how any edits to the page so far violate any of them. There will often be tension between an accurate presentation of technical topics and common perceptions about that topic, and finding the balance between readability and accuracy is always a challenge.

Is the current content either unreadable or inaccurate? --Vineviz 14:18, 26 July 2019 (UTC)

The language is properly attributed to a cited source. I take it for granted that the quotation is accurate, and that the source is considered authoritative. I've added the qualifier "Within the framework of modern portfolio theory (MPT), diversification can refer to..." because that the context of the cited source, and because obviously that is not the only way in which the word "diversification" is used. For example, by regulation, it has a specific and different meaning when used in the official descriptions of "diversified" and "not diversified." Nisiprius 19:45, 26 July 2019 (UTC)
I have edited the statement further, because according to the cited source, this is not a definition of the simple term "diversification." It is a definition of the specific term "Markowitz diversification." Nisiprius 20:14, 26 July 2019 (UTC)

Response by longinvest

According to William Sharpe, the most diversified portfolio is the Market Portfolio.

"As we have seen, based solely on arithmetic, there are compelling arguments for investing in a low-cost index fund that tracks a widely diversified portfolio with holdings in market-value proportions. We turn now to the first of two theoretical arguments for choosing the most diversified such portfolio available: the market portfolio. Each argument is based on a highly simplified model of a capital market, and each abstracts from many aspects of the real world. As with any theory that abstracts from reality to focus on what are assumed to be the key aspects of a problem, one must judge the conclusions on their merits, not on the realism of the assumptions made in the model that produced them."[1] --longinvest 14:43, 26 July 2019 (UTC)

It might be worth providing an example of how forum member and wiki editor Vineviz interprets the definition of diversification:

"For another thing, what you wrote implied that a portfolio containing stocks, treasuries, and corporate bonds is more diversified than a portfolio containing only stocks and treasury bonds. It is not. "[2]

In other words, he rejects that the market portfolio (stocks and total bonds) is more diversified than a portfolio concentrated into a submarket (stocks and treasury bonds).

I think that the main definition must be clearly written in a way that matches without any ambiguity the idea that the market portfolio is the most diversified. --longinvest 15:02, 26 July 2019 (UTC)

Response by jbranx

We certainly should stick with the definition that the "haystack" is the market portfolio. Nothing gained by confusing members on this point. As Prof. Bessembinder's research last year on domestic stocks and recently on international stocks (see SSRN) shows, a very small percentage of stocks drive returns in the global market and there is limited to no evidence that anyone has found ways to identify those securities beforehand. That said, all farmboys know that not all haystacks look identical. Seems to me there are ways to start with Sharpe and add some useful thoughts. For example, Rekenthaler had this piece yesterday on Morningstar in a couple of key paragraphs:

As Morningstar's James Xiong and Thomas Idzorek point out in "Quantifying the Skewness Loss of Diversification," published this spring in the Journal of Investment Management, the stock market's positive skewness is ignored by conventional asset-allocation techniques. Traditional techniques assume that stocks are normally distributed. The inputs into "efficient frontier" asset-allocation programs typically include the expected mean and standard deviation for an asset--the first and second statistical moments--but not skewness, which is the third moment, and which identifies the asymmetry of a distribution.

This has the effect of showcasing diversification's strength, while covering up a potential weakness. It is well known that holding many stocks rather than a single security reduces variability. That is why 401(k) plans offer mutual funds, not individual equities. What few realize, however, is that the process of diversification reduces positive skewness, over short to intermediate time horizons. And positive skewness is a useful attribute; it has the potential to supersize performance.

From there, discussion of tilts, long vs. intermediate, factors, (with data from historical performance and how to think about individual securities if one is locked in by RSU's etc. would seem to me to be useful. While often discussed, I don't see many BH's who are comfortable in adopting the Sharpe portfolio or Vanguard's assurances of the benefits of international at market weight and global bonds. Well balanced discussion of all these points would appear to me to be useful and provide, as Simplegift suggested, a reference point in the Wiki that can be linked in topics.--Jbranx 16:55, 26 July 2019 (UTC)

Response by longinvest about two semantics and the removal of the warning

There are often differences in the semantics of words, when used by different people. The word risk is a well-known example where some people attach the meaning volatility where other people attach the meaning possibility of loss. I think that this is also the case with diversification.

Some people might consider that a Portfolio A composed of a small-capitalization stocks fund and long-term zero-coupon treasuries fund more diversified (according to some risk and return criteria) than a Portfolio B containing a total-market stocks fund and a total-market bonds fund. Yet, other people might say that Portfolio A only spreads its money into small parts of two large markets, making it concentrated and that Portfolio B spreads its money much more broadly across two entire markets, making it broadly diversified.

I am not claiming that one view is false and the other right. But, I think that our wiki must clearly distinguish between both semantics and prominently display the meaning that matches the use of the word diversification in the context of broad diversification, as often used by Jack Bogle in his writings.

As an example of the use of the word diversification to mean spreading money over an entire market, here's what Jack Bogle wrote in his book The Clash of the Cultures: "In 1975, I created the first index mutual fund, now known as Vanguard 500 Index Fund. Then, as now, I considered it the very paradigm of long-term investing, a fully diversified portfolio of U.S. stocks operated at high tax efficiency and rock-bottom costs, and designed to be held, well, “forever.” It is now the world’s largest equity mutual fund." He was, of course, referring to the Vanguard Total Stock Market Index fund.

Lastly, I disagree with the removal of the warning. The fact that a definition was taken from a book doesn't make it neutral. It stills only presents a specific semantic for the word diversification which is being used, in our forum, to promote concentration of investments in regards to the definition used by Jack Bogle. --longinvest 22:19, 26 July 2019 (UTC)

Response by LadyGeek

To keep the discussion readable, I have added sections to each response. I have also fixed the formatting in jbranx's second paragraph. --LadyGeek 17:09, 26 July 2019 (UTC)


  1. William Sharpe, RISMAT-7 The Market Portfolio,
  2. Bogleheads® forum post: Re: Explain why long-term bonds aren't awesome

Some points or sections I think should be included in any overview of "diversification"

For now, I'm just going to do a quick brain-dump list, without checking details or sources much. These are just points that should be included... somewhere.

1) John C. Bogle said "diversify, diversify, diversify."

2) John C. Bogle also said "diversification is the last refuge of the scoundrel," meaning, I think, that when you have a lousy investment and can't talk about return, or risk-adjusted return, you can almost always claim "diversification."

Here's the quotation:

And let me say this about a better diversifier: Better diversification is the last refuge of the scoundrel. What were we talking about five years ago as a good diversifier? Well, | can’t remember, but it wasn't gold. And when gold does well, as it certainly has, then someone says it's a great diversifier. And when international bonds get a little ahead of U.S. bonds—not before, but after—then someone says it's a great diversifier. Anything that's done well recently is considered a great diversifier.

--The Man in the Arena: Vanguard Founder John C. Bogle and His Lifelong Battle to Serve Investors First Knut A. Rostad, John Wiley & Sons, 2013

3) We all know this disclaimer, "Past performance is no guarantee of future results." There's another one, equally important, that you will find if you look for it: "Diversification does not ensure a profit or protect against a loss in a declining market."

4) Regulatory meaning of "diversified." Most mutual funds are "diversified." If they have more that X% of their portfolio in a single stock, or if they hold more than Y% of the stock outstanding in a single company, they must state that "the fund is not diversified." John C. Bogle has noted that this requirement means that diversified index funds are almost forced to become closer and closer to the composition of the market as their assets grow.

5) There are limits to the amount of risk reduction that can be achieved by diversification within the universe of stocks. Vanguard has a rough classification of all of its mutual funds and ETFs into five risk potential categories. The Vanguard Total Stock Market Index Fund is in category 4. There are no stock funds that Vanguard is willing to put at any lower category. That includes the new "minimum volatility" funds, and it includes Total World (which mixes US and international stocks).

6) I feel quite certain that there is no single universally accepted definition of the word "diversification" except in the vaguest and broadest sense, such as "To distribute (investments) among different companies or securities in order to limit losses in the event of a fall in a particular market or industry." (American Heritage Dictionary). The article should make this explicit and illustrate and acknowledged different definitions. Incidentally, I hadn't checked before and I find it interesting that this particular dictionary definition clearly refers specifically to companies and securities (not "alternatives").

In reviewing the various meanings of "diversification," I notice a useful note by vineviz in his thread on "Yes, you can diversify a market portfolio."

  • Some people view diversification as spreading their investment capital over a large number of assets. For them, the market portfolio is as diversified as you can get.
  • Other people view diversification as taking no more or less risk than the market portfolio. This leads, via circular argument, to the conclusion that the market portfolio is as diversified as you can get.
  • Some people view diversification as as spreading their investment risk over as many uncorrelated sources of risk as possible. For them, the market portfolio can definitely be further diversified.
  • Still other people view diversification as minimizing the volatility of their portfolio. For them, the market portfolio can definitely be further diversified.

Nisiprius 20:19, 26 July 2019 (UTC)

Jbranx: Adding a note to remember some good points on the topic by Bill Bernstein. Efficient Frontier is not search friendly, but here's a Ben Carlson link with a couple of Bernstein quotes:, such as:

“Early adopters reap the initial high returns and low correlations of a novel asset class; then one or more multiple academic and trade journal articles will describe those benefits, always accompanied by plump, curvaceous two-dimensional mean-variance plots. Last come Readers Digest versions in the mass media.”

“In short, resign yourself to the fact that diversifying yourself among risky assets provide scant shelter from bad days or bad years, but that it does help protect against bad decades and generations, which can be far more destructive to wealth.”

“Building a widely diversified portfolio is surprisingly simple. Alas, maintaining it properly involves an appreciation of both the valuations of its individual asset class components and the character and discipline of its owners, something that the nation’s largest institutional investors and their clients may not be doing particularly well.”

All quotes from: Skating Where the Puck Was: The Correlation Game in a Flat World (Investing for Adults) Paperback – December 29, 2012. All of this may well be summarized succinctly in SimpleGift's Bernstein collection. --Jbranx 20:39, 26 July 2019 (UTC)

The collection is in this wiki page: Classic Bernstein --LadyGeek 20:58, 26 July 2019 (UTC)

Response by LadyGeek

I have created a draft page here: User:LadyGeek/Diversification

Please use the draft page for further edits, as we don't want to mislead readers (further) with a "work in progress". When we're done, the content can be copied to Diversification.

Also use this page to obtain a consensus with Bogleheads® forum topic: De-Risking and Diversification aren't the same thing.
--LadyGeek 20:53, 26 July 2019 (UTC)

Grotesquely wrong statement?

The article states that "The rationale behind this technique is that a portfolio constructed of different kinds of assets will, on average, yield higher long-term returns and lower the risk of any individual holding or security.." It cites this Investopedia article.

The attribution and quotation are accurate.

I think that this is so egregious wrong that a) it shouldn't be in the article, and b) we should disqualify Investopedia as a reliable source.

For an example of how wrong it is: 1926-2017,

Mean return: stocks alone 12.056%. 45/55 portfolio: 8.52%. So the portfolio did not yield higher long-term returns than stocks.

Standard deviation: bonds alone 9.815%. 45/55 portfolio: 10.421%. So, the portfolio did not "lower the risk" of bonds.

In this case, and in most real-world cases, the portfolio will have a return that is in between the returns of the highest and lowest individual holdings, and a standard deviation that is in between the returns of the highest and lowest individual holdings.

The MPT magic is that the return is equal to the weighted average of the returns of the components, but the standard deviation is lower than the weighted average of the returns of the components.

Investopedia has oversimplified this to the point of falsehood.

One can try to read the author's mind and say "they probably meant to say 'risk-adjusted return,' but that isn't what they said.

Nisiprius 14:43, 27 July 2019 (UTC)

Reply by vineviz

As discussed in the "de-risking" thread, I think this Investopedia statement isn't technically wrong but I do think it is probably not very helpful to the average investor. --Vineviz 19:20, 27 July 2019 (UTC)