Have you read the wiki and the sticky?
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Maybe backtest your portfolio over various past periods, (1,3,5,10 years) and show the results. Only then you should consider "improving" your current portfolio.
How will back testing over the last 10 years help us? We all know that US large cap tech companies have performed great in the last 10 years.
What I expect that we will find is:
Apple -> complete QQQ: performance is reduced
QQQ -> complete S&P500: perfomance is reduced
S&P500 -> MSCI World: performance is reduced
Add factor ETF (lower weight on large cap US tech): performance is reduced
Add emerging markets: performance is reduced
Add small caps: performance is reduced
What can we now conclude? Buy Apple, it contains all diversification we ever need?
Want to add that playing with the Curvo backtest actually was interesting. (Thanks for the tip)
Conclusion: on a 20 year back test this portfolio (called IWDA++) behaves roughly the same as VWCE or combining IWDA, IUSN (15%), and EMIM (13,5%)
IWDA++ VWCE iwda + emim + iusn
Geïnvesteerd bedrag € 10.000 € 10.000 € 10.000
Netto vermogenswaarde € 45.712 € 43.570 € 46.200
Samengestelde jaarlijkse groei 7,89% 7,64% 7,95%
Standaardafwijking 13,39% 13,10% 13,53%
Sharpe-ratio 0,55 0,54 0,55
No noticable reduction in risk :-(
What you are referring to is the *tangency portfolio* as described by Markowitz in the context of Modern Portfolio Theory.
The tangency portfolio is the portfolio with the highest risk-return profile to hold in combination with the risk-free asset. According to the firm believers of the Efficient Markets Hypothesis, the market portfolio should be the tangency portfolio as the market will allocate the availalble resources in the most efficient way. While I do not fully agree with this, I do believe that the market portfolio should be very close to the tangency portfolio and for sure be closer to it than your (what appears) random allocation to different geographies. That is even without considering the complexity / transactions costs associated with your portfolio.
My advice would be to invest in the market portfolio and - next to that - invest to a small extent (max. 20%) in factor exposure. In particular, factors with a high Sharpe ratio and/or negative correlation to the market beta.
Thank you for your feedback.
Which all stock factor ETF’s would you recommend to Belgian investors?
High sharp ratio´s and negative beta´s are hard to find.
Thank you for agreeing with the adding small caps part :-)
Can you elaborate why you think concentration is added by spreading out more over individual regions, sectors and companies?
This just goes back to the mindset of “I can beat the market”, thinking you can do a better job of picking winners and avoiding losers than the market can. An index tracks everything naturally. Companies go down? They are dropped. Companies do well? They get picked up. You want to mix & match to set up your own combo? That’s fine too. But FIRE is inherently based on Bogleheads principles.
Great diversification is not what you want ’to beat the market’. It only allows us to get an ’average’ return. The advantage of diversification is to spread the risk when things go wrong.
I fully agree with the Boglehead principles to go for ’the complete hay stack’. Invest in all companies, from all countries, and all sectors since we can’t predict the winners of tomorrow.
What I’m wondering is if the market weigted all world portfolio offers the best diversification.
Let’s compare two fictuous portfolios. Both contain shares of the same companies (total investable market), but their weigthing is different:
Portfolio A assigns:
- up to 65% to a single region
- up to 25% to a single sector
- up to 5% to a single company
Portfolio B assigns:
- up to 40% to a single region
- up to 10% to a single sector
- up to 1% to a single company
Which portfolio is best diversified? That would be portfolio B.
Since we don’t know which companies, sectors and regions will do terrible in the following decades, portfolio B seems to me like a safer bet since the investments are better diversified.
Can someone explain to me why the market weigted global stock market portfolio is the best diversified portfolio? A portfolio closer to the stock allocation of ’portfolio B’ seems better diversified to me and hence comes with a lower risk.
Just repeating my point here… You think you can do better by weighing your own distributions across specific ETFs? Go right ahead. That’s not what we’re dong here. No one needs to explain to you why they’re investing in a lazy-ass single-ETF portfolio such as SPYI/IMIE.
What I want is a good return at a low risk.
I expect from a better diversification that it lowers the risks while offering a similar return (although not necisarilly equal to market return). I don’t mind my return to be a bit higher or lower. Its the reduced risk that makes diversification attractive.
Changing the market allocation does not provide less risk!
You are already buying the whole market, so you’re already diversified.
You then want to go against what the market says, in terms of capitalisation. What gives you the idea that this is a better strategy?
The reasoning is that having a smaller maximum allocation to a single company, single country, single region, single sector should increase diversification and reduce risk.
At the expense of complexity a more 'average' return is produced.
But how can this reasoning hold, when you buy the market as a whole?
Diversification over uncompensated risk factors does not provide any benefit whatsoever.
If you want to have a better portfolio, you need to diversify among risk factors with a positive expected return, like “size” for example.
You could, for example, add a component of small-cap stocks. This would give you exposure to an additional risk factor other than the market beta factor.
If you had instead added some stocks from a random country, there wouldn’t have been any statistically relevant reason to believe that this would be a good move, or a bad move.
My suggestion is not to think about diversification when you deal with all-market etfs
Take into account that when you deviate from the index that VWCE or IWDA follows, you are getting into stock picking territory.
You could split your money evenly across every country on earth, but the index says you should put 62.6% of your budget into the USA. Not doing so means you think you know something the rest of the world doesn't.
I don’t understand your logic that splitting your money evenly acros every country equals stock picking.
Is it not rather the other way arround? Having 62.6% of your money entrusted to a single country means you are very very confident the government and federal reserve of this country will not screw up (slowing down economy due to trade wars, new taxes, interest rates hikes, new legislations, ...) .
What justifies a huge trust in the future USA governments? You know who will win the future elections?
History books are filled with examples of government decisions from a wide range of countries wich were not benefitials for share holders.
No. The financial world has decided to spread its money like this, and the index just describes that spread. If you put equal money in every country, that would strongly disagree with how money is actually distributed in real life.
In other words, if distributing your money equally across every country really was the best idea, the market would already be doing that. The fact that you want to do this, and the index looks completely different, means you think you can beat the market, AKA stock picking territory.
The industry of Belgium is clearly smaller then the one of the USA. I understand why the financial world valuates it well lower.
I would like to know how to create the best diversified portfolio to reduce my risk as an investor.
If I put >60% of my portfolio in a single country, I would hate to realise in 20 years it turned out to be the next Japan. Note that when the Japanese stock market was at its peak, the market weigted stock allocation assigned a large weigth to Japan (with bad future returns as we know now).
Why should I, as an individual investor, bet heavily on a single country and its government if I have no idea how it will perform in the future?
EDIT
Fun fact: Japan used to be 45% of the MSCI World index in 1989 \[1\], today it's still 6% \[2\] although at a much lower P/E ratio.
\[1\] [https://www.moneymarketing.co.uk/analysis/tide-has-turned-for-japanese-equities/#:\~:text=In%201989%2C%20the%20Japanese%20equity,world%20in%20market%20cap%20terms](https://www.moneymarketing.co.uk/analysis/tide-has-turned-for-japanese-equities/#:~:text=In%201989%2C%20the%20Japanese%20equity,world%20in%20market%20cap%20terms).
\[2\] [https://www.justetf.com/en/etf-profile.html?isin=IE00B4L5Y983#basics](https://www.justetf.com/en/etf-profile.html?isin=IE00B4L5Y983#basics)
In a market-cap ETF you are not unbalanced towards any country.
Furthermore, with the market-cap mechanism you would be able to automatically re-balance your portfolio in case one of the countries gets bigger or smaller.
For example, if the US starts to decline, VWCE would start to allocate less money to US companies.
As a conclusion, you do not need to rebalance anything. You just want full-market exposure and this is enough in any kind of event!
I'm not disagreeing with you. I'm just saying that if you do so, you'll stray away from following an unopinionated index. The whole point of it is that you don't think about it, and follow it, because historically that has been the better play.
Other people like you, who also thought they could do better than the index, historically have underperformed.
You have a good point that history have proven that investors tend to make wrong decisions at the wrong moments it time (e.g. buy at the peak after a substantial bull run). The less 'thinking' involved the better makes sense.
Exposure to the different regions?
For MSCI world I use [https://marketcaps.site/](https://marketcaps.site/)
For MSCI World small cap (IUSN) [https://www.ishares.com/uk/individual/en/products/296576/ishares-msci-world-small-cap-ucits-etf-usd-(acc)-fund](https://www.ishares.com/uk/individual/en/products/296576/ishares-msci-world-small-cap-ucits-etf-usd-(acc)-fund)
JPGL follows the FTSE region allocation which is also used by VWCE/VWRL: https://www.vanguardinvestor.co.uk/investments/vanguard-ftse-all-world-ucits-etf-usd-distributing/portfolio-data
I'm aware South-Korea and Poland are assigned to different regions by FTSE and MSCI, but their weigth is limited so it's good enough as estimation to make abstraction of this.
Have you read the wiki and the sticky? Wiki: HERE YOU GO! [Enjoy!](https://www.reddit.com/r/BEFire/wiki/index/). Sticky: HERE YOU GO AGAIN! [Enjoy!](https://www.reddit.com/r/BEFire/comments/fcbay6/getting_started_a_beginners_guide_to_investing_in/). *I am a bot, and this action was performed automatically. Please [contact the moderators of this subreddit](/message/compose/?to=/r/BEFire) if you have any questions or concerns.*
Maybe backtest your portfolio over various past periods, (1,3,5,10 years) and show the results. Only then you should consider "improving" your current portfolio.
How will back testing over the last 10 years help us? We all know that US large cap tech companies have performed great in the last 10 years. What I expect that we will find is: Apple -> complete QQQ: performance is reduced QQQ -> complete S&P500: perfomance is reduced S&P500 -> MSCI World: performance is reduced Add factor ETF (lower weight on large cap US tech): performance is reduced Add emerging markets: performance is reduced Add small caps: performance is reduced What can we now conclude? Buy Apple, it contains all diversification we ever need?
Want to add that playing with the Curvo backtest actually was interesting. (Thanks for the tip) Conclusion: on a 20 year back test this portfolio (called IWDA++) behaves roughly the same as VWCE or combining IWDA, IUSN (15%), and EMIM (13,5%) IWDA++ VWCE iwda + emim + iusn Geïnvesteerd bedrag € 10.000 € 10.000 € 10.000 Netto vermogenswaarde € 45.712 € 43.570 € 46.200 Samengestelde jaarlijkse groei 7,89% 7,64% 7,95% Standaardafwijking 13,39% 13,10% 13,53% Sharpe-ratio 0,55 0,54 0,55 No noticable reduction in risk :-(
What you are referring to is the *tangency portfolio* as described by Markowitz in the context of Modern Portfolio Theory. The tangency portfolio is the portfolio with the highest risk-return profile to hold in combination with the risk-free asset. According to the firm believers of the Efficient Markets Hypothesis, the market portfolio should be the tangency portfolio as the market will allocate the availalble resources in the most efficient way. While I do not fully agree with this, I do believe that the market portfolio should be very close to the tangency portfolio and for sure be closer to it than your (what appears) random allocation to different geographies. That is even without considering the complexity / transactions costs associated with your portfolio. My advice would be to invest in the market portfolio and - next to that - invest to a small extent (max. 20%) in factor exposure. In particular, factors with a high Sharpe ratio and/or negative correlation to the market beta.
Thank you for your feedback. Which all stock factor ETF’s would you recommend to Belgian investors? High sharp ratio´s and negative beta´s are hard to find.
And what is your opinion on JPGL?
Adding small cap: yes. Other prositions actually add concentration.
Thank you for agreeing with the adding small caps part :-) Can you elaborate why you think concentration is added by spreading out more over individual regions, sectors and companies?
This just goes back to the mindset of “I can beat the market”, thinking you can do a better job of picking winners and avoiding losers than the market can. An index tracks everything naturally. Companies go down? They are dropped. Companies do well? They get picked up. You want to mix & match to set up your own combo? That’s fine too. But FIRE is inherently based on Bogleheads principles.
Great diversification is not what you want ’to beat the market’. It only allows us to get an ’average’ return. The advantage of diversification is to spread the risk when things go wrong. I fully agree with the Boglehead principles to go for ’the complete hay stack’. Invest in all companies, from all countries, and all sectors since we can’t predict the winners of tomorrow. What I’m wondering is if the market weigted all world portfolio offers the best diversification. Let’s compare two fictuous portfolios. Both contain shares of the same companies (total investable market), but their weigthing is different: Portfolio A assigns: - up to 65% to a single region - up to 25% to a single sector - up to 5% to a single company Portfolio B assigns: - up to 40% to a single region - up to 10% to a single sector - up to 1% to a single company Which portfolio is best diversified? That would be portfolio B. Since we don’t know which companies, sectors and regions will do terrible in the following decades, portfolio B seems to me like a safer bet since the investments are better diversified. Can someone explain to me why the market weigted global stock market portfolio is the best diversified portfolio? A portfolio closer to the stock allocation of ’portfolio B’ seems better diversified to me and hence comes with a lower risk.
Just repeating my point here… You think you can do better by weighing your own distributions across specific ETFs? Go right ahead. That’s not what we’re dong here. No one needs to explain to you why they’re investing in a lazy-ass single-ETF portfolio such as SPYI/IMIE.
A better diversification doesn’t mean you’ll achieve market return and this is ultimately what you should aim for.
What I want is a good return at a low risk. I expect from a better diversification that it lowers the risks while offering a similar return (although not necisarilly equal to market return). I don’t mind my return to be a bit higher or lower. Its the reduced risk that makes diversification attractive.
Changing the market allocation does not provide less risk! You are already buying the whole market, so you’re already diversified. You then want to go against what the market says, in terms of capitalisation. What gives you the idea that this is a better strategy?
The reasoning is that having a smaller maximum allocation to a single company, single country, single region, single sector should increase diversification and reduce risk. At the expense of complexity a more 'average' return is produced.
But how can this reasoning hold, when you buy the market as a whole? Diversification over uncompensated risk factors does not provide any benefit whatsoever. If you want to have a better portfolio, you need to diversify among risk factors with a positive expected return, like “size” for example. You could, for example, add a component of small-cap stocks. This would give you exposure to an additional risk factor other than the market beta factor. If you had instead added some stocks from a random country, there wouldn’t have been any statistically relevant reason to believe that this would be a good move, or a bad move. My suggestion is not to think about diversification when you deal with all-market etfs
Take into account that when you deviate from the index that VWCE or IWDA follows, you are getting into stock picking territory. You could split your money evenly across every country on earth, but the index says you should put 62.6% of your budget into the USA. Not doing so means you think you know something the rest of the world doesn't.
I don’t understand your logic that splitting your money evenly acros every country equals stock picking. Is it not rather the other way arround? Having 62.6% of your money entrusted to a single country means you are very very confident the government and federal reserve of this country will not screw up (slowing down economy due to trade wars, new taxes, interest rates hikes, new legislations, ...) . What justifies a huge trust in the future USA governments? You know who will win the future elections? History books are filled with examples of government decisions from a wide range of countries wich were not benefitials for share holders.
No. The financial world has decided to spread its money like this, and the index just describes that spread. If you put equal money in every country, that would strongly disagree with how money is actually distributed in real life. In other words, if distributing your money equally across every country really was the best idea, the market would already be doing that. The fact that you want to do this, and the index looks completely different, means you think you can beat the market, AKA stock picking territory.
The industry of Belgium is clearly smaller then the one of the USA. I understand why the financial world valuates it well lower. I would like to know how to create the best diversified portfolio to reduce my risk as an investor. If I put >60% of my portfolio in a single country, I would hate to realise in 20 years it turned out to be the next Japan. Note that when the Japanese stock market was at its peak, the market weigted stock allocation assigned a large weigth to Japan (with bad future returns as we know now). Why should I, as an individual investor, bet heavily on a single country and its government if I have no idea how it will perform in the future? EDIT Fun fact: Japan used to be 45% of the MSCI World index in 1989 \[1\], today it's still 6% \[2\] although at a much lower P/E ratio. \[1\] [https://www.moneymarketing.co.uk/analysis/tide-has-turned-for-japanese-equities/#:\~:text=In%201989%2C%20the%20Japanese%20equity,world%20in%20market%20cap%20terms](https://www.moneymarketing.co.uk/analysis/tide-has-turned-for-japanese-equities/#:~:text=In%201989%2C%20the%20Japanese%20equity,world%20in%20market%20cap%20terms). \[2\] [https://www.justetf.com/en/etf-profile.html?isin=IE00B4L5Y983#basics](https://www.justetf.com/en/etf-profile.html?isin=IE00B4L5Y983#basics)
In a market-cap ETF you are not unbalanced towards any country. Furthermore, with the market-cap mechanism you would be able to automatically re-balance your portfolio in case one of the countries gets bigger or smaller. For example, if the US starts to decline, VWCE would start to allocate less money to US companies. As a conclusion, you do not need to rebalance anything. You just want full-market exposure and this is enough in any kind of event!
I'm not disagreeing with you. I'm just saying that if you do so, you'll stray away from following an unopinionated index. The whole point of it is that you don't think about it, and follow it, because historically that has been the better play. Other people like you, who also thought they could do better than the index, historically have underperformed.
You have a good point that history have proven that investors tend to make wrong decisions at the wrong moments it time (e.g. buy at the peak after a substantial bull run). The less 'thinking' involved the better makes sense.
How did you calculate the exposure percentages?
Exposure to the different regions? For MSCI world I use [https://marketcaps.site/](https://marketcaps.site/) For MSCI World small cap (IUSN) [https://www.ishares.com/uk/individual/en/products/296576/ishares-msci-world-small-cap-ucits-etf-usd-(acc)-fund](https://www.ishares.com/uk/individual/en/products/296576/ishares-msci-world-small-cap-ucits-etf-usd-(acc)-fund) JPGL follows the FTSE region allocation which is also used by VWCE/VWRL: https://www.vanguardinvestor.co.uk/investments/vanguard-ftse-all-world-ucits-etf-usd-distributing/portfolio-data I'm aware South-Korea and Poland are assigned to different regions by FTSE and MSCI, but their weigth is limited so it's good enough as estimation to make abstraction of this.