Welcome to Quinn Financial Planning’s view on planning and investing. I have been helping clients in all areas of financial planning for over 15 years and I have been a practicing tax CPA for over 25 years. My knowledge extends from assisting Gen X and Gen Y investors who are just starting out, to retirees who want to determine their income needs and enjoy a comfortable retirement.
Recently I read an abstract co-authored by Srinidhi Kanuri and Robert W. McLeod titled, Does It Pay to Diversify— U.S. vs. International ETFs? The abstract, published in Financial Services Review, made me stop and address something that has bothered me for quite some time.
The abstract illustrated the higher risk-adjusted performance of U.S. exchange traded funds (ETFs) versus International ETFs over a period from January 2008 through June 2013. Some experts might say that the data set is incomplete because the time frame studied is not long enough. The sample size is too small. I disagree, because in today’s technologically advanced and connected society, the more current the data, the more relevant. But that’s beside the point.
What bothers me is not so much the U.S. vs international ETF investment performance argument, rather the focus should be on the much broader subject of “diversification.” Here’s why: While diversification in theory is always advisable and easy for most investors to understand in a broad sense, the type of diversification often peddled by advisers does a great disservice to their investors. I am willing to bet that a vast majority of financial planners or investment planners believe in or promote the theory that a “well-diversified” portfolio in the long run is best suited for the investing general public. I bet that if you walked into or spoke with several financial advisors they would explain basically the same indistinguishable thing—and I speculate it would go something like this:
“We will diversify your investments across a broad array of asset classes or indexes using Large Cap, Mid Cap, and Small Cap growth and value companies, as well as mutual funds or ETFs. We will also include some short- and mid-term bonds, or bond mutual fund or ETFs, and will introduce international large and small companies, Large and Small Cap mutual funds, or ETFs. We will even recommend real estate funds, both U.S. and internationally based, and precious metal funds or commodity funds.”
Or investors will hear the “Core-and-Satellite” approach from investment pitch people, which is essentially the same spiel:
“You start out with core holdings of maybe some U.S. and international stocks or mutual funds, along with some bond funds. Then surrounding the core we have some “satellite” investments, with U.S. and international Small Company value funds or ETFs, and another satellite of real estate, commodity, or gold funds.” You get the picture.
And the end result is the investor has investment mush.
I take a more judicious approach to a well-diversified theme of investing. I understand and implement all the good tenets that the diversification notion has to offer, the most important one being the risk-mitigating factor. This helps smooth out investment returns over a period of time, especially in times of stock market stress. However, I keep it pretty simple between company stocks (owned individually or through mutual funds or ETFs) and bonds.
I get suspicious or critical of the herd mentality of investment companies that promote pretty much the same thing—a routine of assembling a “well-diversified” mixture of ETFs and mutual funds that frankly are all over the place in the name of diversification, but lacking where it truly counts—returns.
I wonder how many “diversified ETFs and mutual funds” reside in Buffet’s, Icahn’s, Zuckerberg’s, or Gates’ investment portfolios?