User talk:LadyGeek/Diversification

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Nedsaid's proposed outline

(Grist for our mill)

Following text is by Nedsaid:

Here is a framework I would recommend to discuss diversification:

Note: This section deals with the elements of diversification. The more traditional Bogleheads focus upon elements 1-4. Those who like to factor tilt also incorporate 5 and 6.

1) Diversification across thousands of securities as in the Total Stock and Total Bond Indexes as opposed to hundreds of securities in more focused portfolios. Wide diversification vs. Narrow diversification. 2) Diversification across the basic asset classes: stocks, bonds, cash. These are financial assets. 3) Diversification across Geography: US only vs. International. 4) Time Diversification. Lump Sum vs. Dollar Cost Average. 5) Diversification across sub-asset classes. REITs and other industry sector funds would be sub-asset classes within stocks. Diversification across industry groups for both stocks and bonds is included in this category. Treasuries, TIPS, Agency Bonds, Corporates, Munis, and High Yield would be sub-asset classes within bonds. This is a tilting strategy. In the case of bonds, an investor could add TIPS and High Yield which are not in the Total Bond Index. 6) Diversification across factors: Market Beta, Size, Value, Momentum, Profitability, Quality, Low Volatility, and Illiquidity. This is a tilting strategy.

Note: The section below fits more with diversification techniques.

1) Portfolio Insurance, use of asset classes with very little or no real returns over time but which have very low correlation to stocks: Commodities, Currencies, Gold and Precious Metals, Precious Metals Stocks. 2) Alternative Investments. Funds that use leverage, futures, options, shorting techniques such as long/short funds, style premia funds, and market neutral funds. So called interval funds that offer limited liquidity. More illiquid investments like non-traded REITs, Private Equity. These can include the portfolio insurance discussed above. 3) Derivative instruments such as swaps, options, futures. These could be used as portfolio insurance as described above in 1. Also used in the Liquid Alts funds that use leverage, futures, options, and shorting. 4) Hard assets vs. Financial assets. Hard assets are things like directly owned real estate, coins, collectibles, art. Hard assets are tangible items and financial assets are mostly intangible save for physical cash. Hard assets can fall in categories 1, 5, and 6. 5) Assets that are valued on the basis of generated cash flows vs. assets that do not generate cash flows. Assets without cash flows can be more speculative in nature. 6) Assets with daily liquidity vs. Assets with limited liquidity or are illiquid. Boglehead philosophy favors assets with daily liquidity. 7) Use of glidepaths to compensate for decreasing human capital. That is stock heavy portfolios when young and more bond heavy portfolios when you are old.

I would also discuss active vs. passive strategies. Note the continuum between passive, more passive factor strategies, more active factor strategies (momentum), and active. Discuss that passive most often follows an index or uses low turnover/patient trading strategies.

I would also discuss sources of risk. In other words, what are you trying to protect yourself from with diversification. 1) Volatility risk from price movement. 2) Loss of purchasing power risk from inflation. 3) Fundamental risk including such things as leverage, volatility of earnings, liquidation value, competitive advantage (moat). 4) Pricing risk. An asset might be too expensive relative to future potential cash flows. 5) Interest rate risk. Related to fundamental risk. 6) Default risk. Related to fundamental risk. 7) Political risk. 8) Currency risk. 9) Risk of decreasing human capital over time.

Nisiprius 17:07, 13 September 2019 (UTC)