There’s been volumes written on the topic of diversification. The pros, the cons. What diversification really means? How many positions one needs to hold to be diversified?
Here are some good quotes. I doubt I could add anything useful if I tried. However, I mostly agree with the below statement.
“Being truly diversified means that there almost always will be a part of your portfolio that is sucking wind. (Big note: if every piece of your portfolio is working really well, it means one of two things: you’re incredibly lucky or you are not actually diversified. I would assume the latter.)” – De Thomas Wealth Management
Here’s what the holdings look like in my account where I attempt to deploy a broad, diversified, ETF strategy.
Not too much pain here…
I assure you this is a broad mix of ETFs representing equities, fixed income, real estate across U.S., international, emerging markets, etc. Most would call this a well diversified portfolio.
The fact that almost every fund is pegged up against its 52 week high makes me more than nervous. The issue is not that these aren’t funds holding diversified assets. The issue is almost every asset is moving up together and correlations among asset classes are increasing.
“He notes that the correlation between the yield on the Barclays Global Aggregate Bond index and global stocks currently sits at 0.24—a correlation of 1 means two assets move in lockstep—and has been fairly steady since the market stabilized after the coronavirus meltdown. If the correlation turns negative, which would mean that stocks and bonds move in opposite directions, it could be bad news for equities. “ – Barrons
When did stocks and bonds start moving in the same direction? It used to be, they didn’t.
So how do you diversify when correlations are increasing?
Well, if most asset classes are going up, then you probably don’t care about diversification as much or the fact that correlations are increasing. Higher correlations mean assets are moving in the same direction. If that direction is up, then I guess higher correlations are good.
However, you will probably start to care about diversification and correlations more if the wheels start coming off. I’ve found this chart helpful in thinking through that problem historically.
Although as the chart says, past performance is not an indication of future performance.