Dilbert on Diversification

Scott Adams, the author/creator of the Dilbert comic strip, has some very sensible things to say about asset diversification in this great blog post, World’s Simplest Portfolio:

First, let’s assume the hypothetical money is invested entirely for retirement, so we don’t need to worry about keeping any of it liquid for college or buying a house. That assumption is just to keep things simple.

Second, we’re only talking about investments up to 10 years prior to your planned retirement…

I suggest, as a starting point for our discussion, that a perfectly adequate simple portfolio for young(ish) people might involve putting 50% of your money in an ETF from Vanguard (VTI), which captures the entire Wilshire 5000 … The fees for the ETF are a low .015% per year, and because ETF managers don’t do much buying and selling within the portfolio, it doesn’t generate much taxable income to pass along to investors…

For the remaining 50% your investments, let’s say you buy the Vanguard Emerging Market ETF (VWO) with a .27% expense ratio. That gives you a play on the best companies in emerging markets around the world, at low cost, with excellent diversity, and low taxes.

Asset diversification really can be just this easy.? Adams’s advice underscores how bizarre the diversification message is in E*Trade’s? “Wolf Call” commercial:

What does it mean to diversify like a wolf?? In a world with low-cost stock indexes, asset diversification is downright boring.? Hardly something to brag about to your girlfriend.

Adams’s post, however, makes a claim with which I take issue.? He says:

I picked 50% to allocate to this investment because I contend that no expert has a good reason for picking a different figure. Some experts might tell you 25% is the right allocation for U.S. stocks, and some might say 75%. I contend that most allocation recommendations of that sort are no more defensible than horoscopes.

Adams is right when it comes to traditional allocation advice.? In?Lifecycle Investing, we similarly criticize the “birthday rule,” which arbitrarily advises investors to allocate “110 minus your age” in stock.? The birthday rule counsels 20-year-olds to invest 90 percent of their portfolio in stock, and 60-year-olds to allocate 50 percent to stock.? Adams is right that such advice has become the industry consensus without the benefit of good theory or empiricism.

But Barry Nalebuff and I derive an optimal allocation rule that maximizes expected utility for an investor with constant relative risk aversion:

Samuelson share = Return/(Risk2 * Risk Aversion).

In?a recent post, I showed how this allocation equation can be updated to take into account changed expectations about risk and return.?Lifecycle Investing shows that this allocation equation (when properly applied to the present value of current and future savings contributions) will often lead young people to invest 200 percent of their current portfolio in stocks.

Adams’s approach still wins hands down in a simplicity contest (and in fact, before I wrote this book my portfolio emulated his advice).? But we show that there are substantial gains from doing some extra work to better spread market risk across time.? Historically, the Leverage Lifecycle approach can reduce risk by more than 20 percent.? Or, the benefits of this new diversification technology can be channeled to safely increase your expected return by 60 percent.? Until a mutual fund has the good sense to automate our system (we’re working on it), time diversification will require some additional work.? But doing a better job diversifying risk across time can be worth the effort.

(Hat Tip:?Joshua Gans)


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  1. Eric M. Jones says:

    “Why can’t we concentrate our resources across the board?” (Dilbert 1996)

    Still, the investor (this writer included), believes he can glean some information that gives an edge in the market. In general, it hasn’t worked for me. I have to wonder if this is really anything more than gambling….and the house has it fixed to keep the rubes coming back.

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  2. Dave says:

    What about non-stock assets? Or is he just assuming stocks always go up. We don’t all live 100 years, someone ought to introduce him to the multi decade bear markets that have existed over the past few centuries.

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  3. Dan says:

    Scott Adams is recommending a 50-50 split on the allocation between US stocks and foreign stocks (until you’re within 10 years of retirement). Ian, you’re talking about the allocation between stocks and other investments.

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  4. AaronS says:

    May I make a simple observation? I find that I if I devote myself to a single decent stock, I can get so “in tune” with it, learn so much about it, develop a feel for it, etc., that I can do pretty good with the stock.

    And with a trailing stop-loss, I typically get out with minimal risk even if there is some bombshell moment that takes it or the whole stock market down temporarily (I say temporarily, because if the fundamentals are strong, the stock market WILL recover–just as it did shortly after even JFK’s assassination).

    Yes, I can be “safer” by broad diversification. But there is also vast opportunity cost, I believe. While I maintain greater safety, I “pay” for it by not being in Qualcomm the day it went up over $150 (I was in!). I pay for it by having great advances balanced out by losing stocks.

    There is never full safety in the stock market. You’re going to have to take a risk. I suppose I am just willing to take a bigger risk in order to have the opportunity for greater gains.

    I know that Sirius XM Satellite Radio (one of the few penny stocks I’ve played) has made me thousands over the past year–keeping my head above water even thought unemployed.

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  5. Bob Brown says:

    Let’s hope the new health insurance law has an assisted suicide proviso for those of us whose retirement funds are underwater.

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  6. BenK says:

    In the end, this presumes you have some sensible way of assessing the risk of various investments. In fact, we don’t. The big banks didn’t, the little people don’t, the government doesn’t – and the only people who have some claim on risk assessment (Taleb, for example) has a completely different strategy for investing.

    Mostly, it seems, the informed people spend all their time sucking up insider trading dollars or muttering about the sky falling. So, the wise investor just avoids being taken to the cleaner, does his daily job well, and hopes to maintain his home, family and employment.

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  7. Kevin H says:

    Doesn’t both the ‘risk’ term and the ‘return’ terms in your equation blow up when your time horizon gets large?

    That would make the equation very unstable to minor mis-calculations of risk and anual-return. A classic example of spurious specificity, which is basically what Scott Adams is saying.

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  8. hello says:

    For anyone who cares………..

    the constitutents of any market-cap-weight emerging market index fund basically mimics the SP500 (eg big cap energy, tech and financials).

    Yes, you are getting some intl exposure but you’re not elimating much risk. And your “portfolio” is heavily dependent on energy and discretionary consumer spending.

    for the past decade all the world’s stock markets have extremely high correlations bu splitting your portfolio up solely among stocks is up to you.

    My anonymouse suggestion:

    50% US small caps (IWM). 50% carry trade (DBV) (or 50% small cap emerging market).

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  9. Ignatius Goronzola says:

    Everyone has their magic formulae, I suppose. Irrespective of this, one should look at fundamentals. Is the market cheap by historical standards? What is the P/E? Splitting your portfolio to five decimals won’t help if you are getting in when it is too pricey. Diversification won’t help, because stocks are correlated – if AT&T goes down, then so does GE. On the other hand, it’s harder to go wrong if the market has taken a beating and is down below its long term averages. This can be true for short term dips, not just crashes. Then there is the question of dividends. Too often, people (including fund managers) chase the mirage of growth, and ignore stocks that pay a nice reliable 5% a year, plus inflation. So here’s my advice: get a good feel what reasonable dividends and PEs are, over a 50 year time span. Pick a nice portfolio of boring dividend paying stocks with a P/E below 15. Put them in a spreadsheet. And then wait for a dip in the market, and buy them. Buy when other people are scared, not when they’re exuberant.

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  10. assumo says:

    What percentage should I keep hidden under my matress?

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  11. Robert says:

    Before you read another book on investing read “Extraordinary Popular Delusions and The Madness of Crowds.” Published almost 170 years ago it covers the Tulips, the South Seas, the Mississippi etc. etc. It is better than the current crop of bubble books as by its very age it makes clear that human financial foibles have been apparent for a long time, its just that no one ever listens.

    What I don’t like about things like baroque formulas, portfolio theory, financial engineering, or simple minded rules of thumb is that they seem to me like just so much window dressing. In my mind the naked truth is that the financial markets are full of humbug and are made up of ruthless people who want to get rich without really working.

    Most of us poor schmoes are out in the retail world trying to allocate our IRAs or pick between the crap mutual funds our 401Ks provide. If we are smart we have read the tomes on the random walk and feel smug as we index and search for the efficient frontier. But really, aren’t we probably kidding ourselves? This could be 1907 for all we know, in 20 years we could be even more smug, in 23 suicidal, in 30 just poorer.

    I’m not saying that disaster is around the corner, I’m just saying that there is a strong element of deck chair rearranging that makes us look stupid. Beyond that I think there is a rich vein of credulity that the financial press/media have been mining for years and I think we should stop being such suckers for a clever well spoken line gibberish.

    Peace Out.

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  12. Roy Hall says:

    Buy the S&P 500 (ETF IVV)
    you get the top 500 us companies, who are diversified worldwide, represent
    all industries , and are a mix of smaller and larger companies. The ETF allows stop losses, option strategies etc. AND
    seldom does a so called “Pro” beat the index. There is alot of BS published by
    the investment industry.

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  13. Rudiger in Jersey says:

    Dilbert on Diversification:

    Don’t just put your cash under the mattress.
    …..Put some in the fake flower pot. Some in the dog’s favorite plush toy. Some in the frozen foods. And some in the in the hole in the wall.

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  14. Art says:

    The advise to diversify via Vanguard Emmerging Market fund is bad for a practical reason. Not because its a bad fund, but because its hella annoying at tax time to deal with the foreign tax issues if your a turbo tax kind of guy like me.

    It was very bad two years ago when Vanguard stopped providing a form that I had relied on in past years, instead posting foreign tax percentages on their web site, that, with 2-3 hours of calculations, you could perhaps transform into the method of reporting foreign tax that Turbo Tax said was likely best.

    This year, I was finally able to port the Vanguard data into Turbo Tax automatically. Truthfully though, I have no idea which of the two methods of reporting foreign tax I went with, or if I used the best method or not. Might have payed extra, and that annoys me greatly.

    Dont go there, it aint worth it. Stick with the US stocks unless your rich enough to not worry about what you pay your accountant.

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  15. Jerryz says:

    Given the advent of program trading and dark pools replacing market makers I’ve begun to doubt the viability of the market for the retail investor. Traditional tools have no way to adequately protect you and will often leave you at the mercy of the volatility created by the same said programs. ETF run the same risks. That leaves traditional funds. But they now run higher Capitol gains than at any time in history. Again due to program trading. Without a way to shelter those gains. IRA or 401K? How do you stay in the game ?

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  16. Garry Kanter says:

    Here’s the greatest advice of all. In 3 panels, Mr. Adams explains the financial crisis on December 13, 2008:


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  17. malthus says:

    All this talk of diversification reminds me of the old canard of Dollar Cost Averaging, now shown to be silly.

    Any justification for diversification has to lie in the declining marginal utility of money. If winning $10,000 were felt to give the same benefit as not losing $10,000, in other words, diversification would confer no benefit, and if a person felt that winning $10,000 to be better than not losing $10,000, diversity would have negative utility.

    Diversification is also a questionable game plan in marrying and attending to children. It is certainly not advisable for an entrepeneur to invest only a fraction of his time and his start-up funds in his new venture and the rest in diverse ventures.

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  18. wesley.tate says:

    The world markets move as a single unit. Diversification within the world markets in this scenario simply models a volatility level. As such, the only thing this type of “diversification” provides is a likely unwarranted sense of security, and mindless support for the corporate-government partnerships of global brands.

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  19. J says:

    From the mouth of the chief investment officer that I had the pleasure to work for some years ago: “Anyone that tells you that they have a better way to invest surely can’t have one. If they truly did, they wouldn’t tell a soul”

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  20. -Beezley says:

    “The advise to diversify via Vanguard Emmerging Market fund is bad for a practical reason. Not because its a bad fund, but because its hella annoying at tax time to deal with the foreign tax issues if your a turbo tax kind of guy like me. ”

    adams specifically said his hypothetical portfolio was strictly for a retirement scenario/account. thus, i think he also means this would be sheltered in a 401(k) or IRA of some sort. at least that’s how i read it.

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  21. -Beezley says:

    “May I make a simple observation? I find that I if I devote myself to a single decent stock, I can get so “in tune” with it, learn so much about it, develop a feel for it, etc., that I can do pretty good with the stock. ”

    study after study has shown that it’s nearly impossible to beat the market by stock picking over any significant length of time. (i think the studies are typically ten years and longer)

    it’s also not tax efficient.

    buy index funds. slice and dice if you must (for instance, if you believe fama and french and believe in the small value stock premium over time – then tilt a little and buy more of a small value index fund)

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  22. Mike says:

    First of all, it’s not true that pros don’t beat the market. It’s true that they don’t consistently beat the market.

    I disagree that it’s impossible to beat the market by investing in individual equities. First of all, individual equities are one of the more tax efficient vehicles. You only pay when you’ve made a profit.

    Further, by offsetting with losses, you can minimize your tax issues.

    As for the banks not managing risks – you are correct. When you are levered 30:1, it is difficult to withstand a sustained downturn.

    I have always believed that more equities is better. My grandparents (who lived and worked in the great depression) always owned equities. They made out quite nicely by owning equities and not panicking. Part of the problem is the advent of readily available information which (contrary to academic opinion) makes the markets inefficient. Pricing is distorted due to individuals making emotional decisions.

    Diversification is a basic concept, but it works for people who have long time horizons. Which, given the actuary tables for life expectancy, most people have a good time to live yet.

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  23. frankD says:

    in the casino of life, a/k/a the stock market, the professionals cannot distinguish between investment grade and toxic positions so don’t fret if you don’t “get it” either

    diversification is just another tactic to attempt to legitimize the overall process – truth is, diversifying means spreading around your money among various scams and schemes and rip-offs, so statistically it is improbable that all your various positions get exposed as fradulent at once

    DIVIDENDS ! paying dividends used to distinguish solid financial companies showing results by sharing the annual profits with shareholders by paying dividends year after year

    the market price was set by comparing the entities ability to generate results, real cash results, with a real rate of return, without the mumbo-jumbo that muddies the waters today and this worked for many years

    and diversification meant between industrial sectors – like consumer goods and commodities and manufacturing – which earned real profits realized by reaping more than incurring at measured periods as fiscal year ends

    now, like so many enrons operating today, who the heck knows what the products is or how an entity makes a profit or even if it makes a profit – all that matters is the share price

    anyway that’s my two cents

    ft lauderdale

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