I posted this in the Bogleheads forum, and it didn’t get a lot of attention, maybe because Jack Bogle hadn’t already written in four different books. Hopefully somebody here can comment.
I’m looking for some kind of academic or professional research that shows how increasing your exposure to different assets actually explains the volatility of a portfolio. Particularly, I wonder what the excess benefits are to diversifying beyond a basic stock mutual fund and a bond mutual fund.
In other words, Investor A is invested simply in two different mutual funds–an S&P 500 index fund and a LBAB (or whatever it’s called) bond index fund. He has a return of X and stdev of Y.
Investor B invests in both of those funds but also in an international stock index fund. We would assume his return would be higher than X and his stdev would be lower than Y.
Investor C invests in the three mentioned above, but also in an emerging markets index fund.
Investor D invests in all of the above,and also invests in REITs.
Eventually, if you keep going down this path, eventually you’ll find somebody who has large cap value stocks, large cap growth stocks, mid cap value, small cap value, mid cap growth, small cap growth, micro-cap, emerging markets (large and small), foreign (large and small) and “frontier” stocks. They’ll also have ST government bonds, medium-term gov’t bonds, LT gov’t bonds, ST investment-grade corporates, MT investment-grade corporates, LT investment-grade corporates, ST hi-yield corporates, LT hi-yield corporates, investment grade munis (long and short), high yield munis (long and short), TIPS, STRIPS, government zeroes, corporate zeroes, high-yield floating rate corporate debt, commodities, MLP’s, BCP’s, REITS of all shapes and sizes, distressed debt, callable convertible corporates, preferred shares, inverse floaters, CMO’s, CDO’s, LYONs, TIGRs, and bear funds. Oh my!!!
At some point, this becomes a little ridiculous. I can understand diversifying into stocks and bonds, and also into foreign funds. But at what point is there no real benefit to further diversification? (among the asset classes, that is) Does an investor really need exposure to emerging market high yield floating rate callable municipal bonds? What good does that do for them?