December 10, 2025 – Welcome to another post on the ERN blog. This is the third installment in the “How to Lie with Personal Finance” series (please also check out Parts 1 and 2). As always, this is not an instruction manual for deception, but precisely the opposite: it points out the misunderstandings circulating in personal finance. Think of it as an homage to the classic book “How to Lie with Statistics.” On the program today are the lies and misunderstandings surrounding diversification. Don’t get me wrong, I worked in finance, math, and statistics long enough to appreciate the beauty of diversification. But diversification seems to be one of the more misunderstood and misrepresented concepts in the personal finance world. I want to highlight some of those misunderstandings in today’s post.
Let’s get started…
Lie 1: More Stocks = More Diversification
The idea of diversification is that if we add more uncorrelated, or at least low-correlation assets to a portfolio, we can diversify away a large portion of the risk inherent in those individual assets. Some rules of thumb circle around on the interwebs, such as, “You need at least thirty individual stocks to have a sufficiently diversified portfolio.” And there is some truth to that. But does this insight extend to the number of stocks in your ETF? Does that mean that the ITOT (about 2,500 holdings) or VTSAX/VTI (3,500+ holdings) are more diversified than their smaller cousins, IVV or VOO (about 500 holdings each)? Would VTSAX have materially lower risk than IVV and VOO? That’s undoubtedly the “lie” you hear from certain corners of the personal finance world, and why some folks have an obsession with VTSAX.
It turns out that more stocks in your ETF don’t necessarily lead to more diversification. For example, I looked at the returns of three iShares ETFs: OEF, IVV, and ITOT, which replicate the S&P 100, S&P 500, and a U.S. Total Market index, respectively. The standard deviation for the most recent 120-month window (11/2015-10/2025) is very similar across the three ETFs. In fact, the Total Market fund had the highest standard deviation. The 500-share ETF had the lowest standard deviation, the least dramatic worst-case calendar year return, and the lowest drawdown among the three funds.
Similar results hold when comparing Vanguard offerings, for example, VOO vs. VTI. VTI tends to have a marginally higher standard deviation. The worst calendar year and worst top-to-trough drawdown were also slightly worse in the VTI:
Why doesn’t the risk go down as we add more stocks? Here are the main reasons:
- Most indexes are weighted by market capitalization, so there is significant overlap among them. For example, the 100 largest constituents in the S&P 500 account for more than 70% of the index. And the S&P 500 accounts for almost 90% of the U.S. Total Stock Market. So, we can’t just assume that we’ve expanded the universe by 5x when we move from 500 to 2,500 stocks. We’ve really only increased the breadth of our portfolio by about 10%, not multiples.
- Even the non-overlapping portions are highly correlated. In other words, most mid- and small-cap stocks, i.e., part of the total market but not part of the large-cap index, are still highly correlated with the S&P 500. For example, the iShares Mid-Cap ETF (MDY) has an S&P 500 correlation of 0.956. Intriguingly, small-cap stocks, as represented by the iShares Small-Cap ETF (IWM), correlate even more closely with the S&P 500 (0.982) than mid-cap stocks do. (All correlations are for 10/2015-09/2025. Source: my Google Sheet, see tab “ETF Factor Exposures.”)
- And a technical side note: even in the best possible case, where we had access to N uncorrelated return streams with the identical return distributions, the equal-weighted portfolio standard deviation only declines in the square root of N. So, if we increase the number of assets by 5x, the portfolio variance goes down by 80%, so the standard deviation declines only by a factor of the square root of 5. Thus, even in this ideal case, 5x assets reduce risk by only 55% not 80%.
For the technically inclined, the reason there are limits to diversification is as follows. Imagine we represent every stock i’s return through a simple factor model:
R(i,t) = alpha(i) + beta(i) x MarketReturn(t) + IdSyncRisk(i,t), i=1,…,N and t=1,…,T
Any portfolio of stocks i=1,…,N will always maintain its market beta (=market exposure) equal to the weighted average of the underlying stock betas. You might reduce idiosyncratic risk by broadening the index. Still, you might also add more volatility through the backdoor: the smaller stocks you add may have higher betas and/or higher idiosyncratic risk and/or higher exposure to other common factors (like Fama-French’s SMB, HML, etc.) than the large blue-chip stocks. This explains why U.S. Large Cap ETFs seem to have the lowest risk sweet spot, and if you keep adding more exotic small-cap stocks, risk will start rising again, albeit by tiny percentages.
For the record, I hold many different U.S. equity funds. I have two very large retirement plans from former employers. One has the large-cap index as its default, low-expense-ratio offering. The other plan has the total market index as the best (=cheapest) equity option. So, while I’m slightly biased towards the S&P 500 index funds because that’s the bellwether US equity benchmark with slightly lower volatility, I will gladly hold the Total Market index if a large-cap fund is not available or is only available at a higher expense ratio.
Update 12/10/2025 3 PM: Someone asked in the comments section whether the Total market has consistently higher volatility than the Large-Cap index. I found data for VTSAX since late 2000, so here’s the vol comparison chart using 5-year and 10-year rolling windows. The VTSAX volatility is about 1.03x that of the SPY, so about 3% higher.
Lie 2: More ETFs = More Diversification
There are now more ETFs than publicly traded companies in the US. So, lots of gullible people might conclude that we should have expanded diversification so much that we no longer need to worry about risk. Specifically, I frequently hear this personal finance lie that adding more ETFs will give you much better diversification. Often, that lie comes in the form of someone commenting, “Karsten, you use U.S. Large Cap index equity returns in your withdrawal simulations, but you could achieve much better diversification and higher safe withdrawal rates by properly diversifying the equity risk.” I find this argument highly dubious, though.
The most recent prominent advocate of this idea has been Bill Bengen with his new 5.5% safe withdrawal rate. About half of the gain in his purported new safe withdrawal rate is coming from a more diversified portfolio (his claim, not mine, more on that later)—the other half from shifting the goalpost, i.e., being happy with a less secure success criterion. See my brief post on ChooseFI on this topic.
In any case, to achieve more diversification, Bengen splits his proposed 55% equity portion into five equal parts: U.S. Large-Cap, U.S. Mid-Cap, U.S. Small-Cap, U.S. Micro-Cap, and international stocks. The remaining assets are in an intermediate Treasury Bond fund, e.g., iShares IEF (40%), and 5% in T-bills, e.g., an ETF like BIL or SGOV. So, how much diversification would we have achieved during the last 10 years? None. Quite the opposite, the more diversified ETF portfolio would have had a higher standard deviation and a deeper drawdown than the simple portfolio with 55% S&P 500 index stocks.
We can also go back further than 10 years and observe the same pattern. Small-cap stocks and the mid-cap and micro-cap, by extension, will increase your observed volatility. So, if small-cap stocks don’t really lower your portfolio risk, why would Bengen find that small-cap stocks are the panacea to Sequence Risk? Very simply, small-cap stocks outperformed significantly between the 1920s and early 1980s, thereby alleviating much of the Sequence Risk headache in safe withdrawal simulations for some of the worst historical retirement cohorts (1920s, 1960s/70s). For example, the outperformance of small-cap stocks (and, by extension, mid-cap and micro-cap) is evident in the Fama-French dataset; please see the chart below. Between 1926 and about 1982, small-cap stocks outperformed the overall market by over 200%.
Also evident in this chart is that small-cap stocks did not offer any diversification during the Great Depression or the 1970s recessions. Quite the opposite: the Fama-French SMB factor normally declined during significant US recessions, and most of the starkly upward-sloping portions occurred during economic expansions, when the overall stock market also did well.
So, small-cap stocks offered worse risk characteristics, but significant alpha on average. Unfortunately, this alpha has since disappeared. The SMB factor has been flat over the last 45 years because the efficient market has arbitraged away this free-money spring, ever since academics pointed it out to the general public.
So, Bengen’s diversification narrative is a total myth. The diversification story is neither true in the first half of the sample, where SMB was all stock-picking alpha (at the cost of more, not less volatility), nor in the second half where SMB was basically zero extra return plus more risk, nor would any sane person extrapolate the SMB alpha from 40+ years ago into the future, now that the factor has been flat for so long.
Lie 3: Low Correlation = Better Diversification.
Imagine we are looking to add other assets to our portfolio to diversify. What assets would be good candidates? Is there a magic number or indicator we should look for? The correlation between the new asset and the existing portfolio would be a good indicator. The lower the correlation, the better the diversification, right? Not necessarily. Whether adding a new asset lowers your portfolio’s volatility depends on two variables: the new asset’s volatility and the portfolio’s correlation with it. Let’s look at the following numerical example: We start with a portfolio that has a 15% standard deviation. Which of the three assets would be best at lowering our portfolio volatility?
- ETF 1 with a correlation of 0.7 and a standard deviation of 25%
- ETF 2 with a correlation of 0.8 and a standard deviation of 20%
- ETF 3 with a correlation of 0.9 and a standard deviation of 15%
Let’s plot the standard deviations for different asset mixes between the old portfolio and new ETFs; see the chart below. Although it has the highest correlation with the initial portfolio, the third ETF still offers significant diversification. The blue line slopes down and finds a minimum when we add 50% of the new ETF. In contrast, the lower-correlation ETFs are all sloping up, so there is no positive allocation to the new ETFs that lowers the portfolio volatility.
The explanation: I provided the mathematical derivation for this phenomenon last year in my Di-WORSE-fication post, see the screenshot below. The necessary and sufficient condition for the new asset to lower the portfolio variance is that its standard deviation multiplied by its correlation must be less than the existing portfolio’s standard deviation. That’s certainly true for the third ETF (0.9×15%=13.5%<15%), but not for the higher-volatility ETFs 1 and 2, e.g., 20%x0.8 and 25%x0.7 are all larger than 15%.
Many exotic equity ETFs, such as small-cap and small-cap value, have this weakness: their correlations with the S&P 500 remain relatively high, typically around 0.8 to 0.9. They also have much higher standard deviations, usually around 20-25% annualized, compared to only 15-16% in the S&P 500. That makes those ETFs unattractive from a pure risk-reduction perspective. And that’s not even mentioning the underperformance of small-cap value stocks over the last two decades.
Similar arithmetic often applies to individual stocks. For example, many stocks, even large blue-chip companies, have relatively low correlations with the S&P 500. Tesla had a 0.45 correlation with the S&P 500 recently (10/2015-09/2025). But a standard deviation of over 60%. So, since 0.45×60% is much larger than the S&P 500 standard deviation, you would have increased your portfolio volatility. But of course, TSLA would have improved your average returns.
Sidenote (updated on 12/11/2025, 7 PM): People in the comments section wondered how crypto fits into the diversification debate. It’s the same issue as small-cap stocks, but on steroids. Clearly, crypto did very well if you stuck to the major coins like Bitcoin and avoided meme coins and NFTs. Specifically, Bitcoin’s average returns were spectacular, at least before the 2025 peak. So, a healthy share of Bitcoin would have increased your average returns but also massively increased your risk. Your Sharpe Ratio would have likely suffered. So, in a nutshell, the high correlation between Bitcoin and US equities, especially the Nasdaq/QQQ, plus the massive volatility, often 80-100% annualized, would have been anti-diversification. More info here: https://earlyretirementnow.com/2022/04/25/crypto-is-a-bad-investment/
Lie 4: Diversification helps during Bear Markets
When I worked in asset management, we’d often use the phrase “When the sh!t hits the fan, all correlations go to one.” Meaning: I might have return sources that appear uncorrelated, or at least only mildly correlated, during regular times. But during periods of economic and financial stress, those ostensibly uncorrelated assets all feel the pain—one such example: international equities. For instance, in an average day or week, we may see the US index down by 1% and the non-US stock fund up by 1%. But how often do we see the US index down 20% while my non-US equity fund is up 20%? Never! In the chart below, I plot 12-month rolling returns, the S&P 500 on the x-axis, and the bellwether non-US stock index (MSCI World ex USA) on the y-axis. All returns are adjusted for US CPI inflation. Do you notice the funnel shape of returns in this scatterplot? If the US market is down significantly, so is the rest of the world, with very little variation around the 45-degree line. In fact, the standard error of World-ex-US minus the US return is the smallest, only 6.1%, when the US index is down the most (20% or more down). So, non-US returns look most similar to US returns during a bear market. We get the least diversification when we need it the most. And we get the most diversification when we need it the least.
That’s not to say that international diversification is useless. Even if international stocks have gone through the same (or even worse) bear markets as the US, they may recover faster, as they did most recently in the early 2000s after the Dot-Com bust. So there is a diversification benefit, but international stocks are no panacea to market volatility. Anybody who tells you that you can wave the magic wand with international stocks to diversify a US equity portfolio is lying to you. Also see my 2017 post on international diversification.
I should also stress that for investors outside the U.S., you absolutely want to diversify away your idiosyncratic country risk. But that’s much harder for U.S. investors because our business cycle affects most other economies around the world.
Lie 5: With enough Diversification, you don’t have to worry about Expected Returns.
Some people falsely claim that with the proper volatility control, you can easily raise your safe withdrawal rate. Bill Bengen at least kept a high enough equity exposure to give you a chance to make it through a 30-year retirement. Though 55% seems a bit low for the early retirement crowd with a 50+-year horizon.
But some charlatans want to go even further than the new Bill Bengen proposal and come up with more exotic portfolios – Risk Parity, Golden This, Golden That, etc. – involving even lower equity shares. But very often, shifting out of high-volatility/high-return assets like equities and into diversifying assets like bonds, cash, and commodities will reduce your expected returns. If you reduce your equity holdings to only 25% as in the Permanent Portfolio, or 30% as in the “All-Weather Portfolio,” you might have put the (volatility-)cart before the (return-)horse. Or you throw out the (return-)baby with the (risk-)bathwater. Or whatever figure of speech you prefer. In other words, if you replace too much of your risky but high-return assets with diversifying assets that have much lower expected returns, you might hurt your portfolio in the long term. In historical safe withdrawal rate simulations, both of these exotic portfolios underperformed a simple 75% stock + 25% bond portfolio, as I showed in Part 34 of my Safe Withdrawal Rate Series.
Admittedly, while I did find that commodities in general are unhelpful, gold is the one commodity that has shown intriguing diversification properties in most past bear markets, performing well in both deflationary and inflationary recessions. So, mixing in about 10-15% of gold in a retirement portfolio would have slightly increased your failsafe withdrawal rate. After the recent runup in gold prices, though, I’m a bit worried that valuations are stretched and this winning streak might soon end. As a compromise, you might want to pick a dynamic asset allocation strategy, like the Momentum strategy I wrote about last month.
Sidenote (updated on 12/15/2025, 10 AM): Because this issue came up in the comments, I want to point out that diversification is mostly about risk mitigation, i.e., spreading the risk in your portfolio. But we do not want to throw out the baby with the bathwater, so how should we think about diversification and return considerations together? Very easy. Instead of performing the diversification math solely based on portfolio risk as above in Lie 3, we can derive a similar formula for the Sharpe Ratio. Please see below.
Specifically, if and only if the new asset’s Sharpe ratio is higher than the existing portfolio’s Sharpe Ratio multiplied by the correlation between the existing and new assets, then the new asset would improve the portfolio’s Sharpe ratio, at least at the margin. By that measure, many exotic ETFs again face an uphill battle. For example, small-cap and small-cap-value funds still maintain high correlations with the S&P 500 and the high standard deviation of, say, the DFSVX weighs on its Sharpe Ratio. So, very often, exotic ETFs and mutual funds detract from the Sharpe Ratio. To put numbers behind this, the 10/2015-09/2025 stats indicate that the IVV had a Sharpe of 0.87. The DFSVX had a Sharpe of 0.56 and a correlation of 0.78 with the S&P 500. Since 0.56 is smaller than 0.78×0.87=0.68, the DFSVX will lower your Sharpe Ratio. See the calculations and data in my SWR Google Sheet, tab “ETF Factor Exposures.”
Lie 6: You need Diversification while accumulating!
I always bring up my personal FIRE accumulation journey that included two deep bear markets: the Dot-Com and the Global Financial Crisis, which saw the equity market drop by over 50%. Was that unsettling at the time? You bet! But in hindsight, those deep bear markets helped me financially because of Dollar-Cost Averaging. In other words, while you’re still young and accumulating assets for retirement, you should even embrace volatility, at least to a degree. As I’ve written numerous times in my Safe Withdrawal Rate Series, while retirees should fear volatility, especially in the near-term, because they face Sequence of Returns Risk, savers can be more cavalier with it, because their Sequence Risk profile is literally the flipside of the retirees’. That’s because the cash flows of a saver plus those of a retiree are again those of a buy-and-hold investor when monthly contributions and withdrawals are equal. I made this point in Part 14 of the SWR Series. So, a temporary equity market meltdown followed by a swift recovery can be beneficial to the saver, at least in the long run. The implications: 100% equity equity weight during a good chunk of your accumulation path is perfectly fine.
For more details, please see Part 43 of my Safe Withdrawal Rate Series Pre-Retirement Glidepaths: How crazy is it to hold 100% equities until retirement?
Conclusion
There you have it. Six more personal finance lies and myths debunked. And again, I’m not against diversification. I have applied it both personally in my portfolio and professionally when working for a large global asset manager. However, diversification is often abused by financial service industry salespeople to push new products on you. They want you to believe that your simple retirement portfolio with one single equity index fund is not diversified enough. They are lying to you. They want you to replace your low-expense-ratio VTI or VOO with their new offerings, which charge 10x the fees.
So much for today and likely for the rest of the year. I wish you all a peaceful Christmas season and a healthy, prosperous, and Happy New Year!
Thanks for stopping by today! I’m looking forward to your comments and suggestions.
Picture Source: Pixabay.com.
On points 5 and 6, I have to disagree with your conclusions. If one can access leverage at low cost (e.g. via box spreads, or even leveraged ETFs), it seems very beneficial to me for any investor (whether in accumulation or depletion phase) to focus on maximizing risk-adjusted returns first through asset class diversification.
Returns will for sure be low, likely too low for retirees to avoid bankruptcy on a 30+ year timeframe – but leverage then allows you to reach the intended performance at a lower volatility than a 100% stock portfolio (or conversely, reach a higher performance at the same volatility as a 100% stock portfolio)
Thus in theory, even a retiree should be able to increase his SWR that way!
(I am referring here to asset class diversification, not factor or geo diversification within the equity class which indeed is a more controversial debate)
Spoken like an economist!
A physicist, a chemist, and an economist are stranded on a desert island. The only thing on the island besides the three academics is a single can of beans. They are discussing how to get it open.
The physicist suggests that they build a fire and heat up the can until the pressure causes the can to explode.
The chemist says “No, no, the beans will fly everywhere, land on the ground, and get all sandy. Our only food will be ruined.”
Instead, the chemist suggests, they should use the corrosive power of the ocean’s saltwater to eat away at the lid of the can.
The economist protests “that will take too long, we’ll starve before then.”
“I have a better idea,” the economist says. “Assume a can opener.”
Haha, I’m an economist and I can relate!
I agree, to a degree. Your point is along the lines of this post: Lower risk through leverage (https://earlyretirementnow.com/2016/07/20/lower-risk-through-leverage/)
You go to the max-Sharpe-ratio allocation and leverage it up. It’s not that easy in practice though. And also: the Risk Parity allocations are certainly far away from the max-Sharpe portfolio.
Also, leverage in retirement is very risky. See Parts 49 and 52 of my series.
That USA v ex-USA scatter plot is outstanding! It certainly helps to clarify the purpose of international diversification.
Glad you liked it. I was amazed when I saw that shape of the scatter plot, too!
Love the scatterplot. Would this plot supports an international diversification strategy on an all equity portfolio being an advantage during the accumulation phase? And ultimately, would this equate to a higher nominal withdrawal if the total portfolio had grown larger?
I don’t think that this chart either supports or negates the benefits of 100% equities with international exposure.
I want you to be nice… until it’s time to not be nice. Let’s stop referring to charlatans and NAME all the risk parity golden boys who may end up ruining peoples lives with their ultra fitted back tests, portfolio charts and sound bites.
Haha, given your reaction you probably know who we’re talking about. I will leave the honor of naming the charlatans to others, though. 😉
i too listen to the silver-tongued ex-lawyer/ ex-engineer renaissance man and always come back to the same conclusion.. what if he’s wrong? The risk parity stuff is so overly backtest tinkered, but his audience loves playing with percentages of percentages and plugging them into calculators when he himself constantly sound-bites about crystal balls and whatnot… I just try to remember that the overall equity exposure will inform most of the long-term result. Thank you for your recent posts Karsten and hopefully you keep having good article ideas!
Thanks! Yes, that’s what overfitting looks like: tinkering with % and ETFs.
Have you run the numbers for longer time periods for the graphs in Lie 1: More Stocks = More Diversification? I would like to see graphs that include the financial crisis and the dot com crash data.
Yes. This is consistent over longer horizons and other 5-year and 10-year windows. I added a chart in the post.
Thanks Big ERN for the update on some of these new strategies. Could you do something similar with Private Equity and Private Credit? These are now being pushed heavily by experts (potentially due to the high fees). From my perspective, they look illiquid and light on data which makes them hard to evaluate.
Not a good idea. The problem with those asset classes: We have very little reliable data. Rob Berger had a good take on it. See his 5-questions Friday episode from recently:
Wow, every time I read a new post here it makes me feel depressed and think that FIRE is for fools. Nothing works, all my strategies are lies or useless gimmicks.
I’d like to see a post of things that are actually tried and true and work in practice, instead of all the doom and gloom of most posts that makes people work longer and more because it’s never safe to stop.
The math is bleaker than what most are willing to accept.
Yeah, and I thought econ is bad as the dismal science. Math is the bleak science!
I was expecting a little more from your reply ERN. Chalky we know is your bodyguard fanboy that doesn’t have any credit, but you ERN, don’t you want to proof that FIRE is for everyone? Or is it only for ex-FED guys who understand about money and the rest of us are doomed?!
FIRE is not for everyone. I never claimed that.
Somebody is jealous. But let me calm you, Fed jobs are not that prestigious.
Just wow, another elitist!
I’ll put you in the same bucket as the charlatan FV then
Oh, no, please don’t. There is no bucket large enough for Frank and me. At least put me into the “ultra-elitist bucket,” please. I don’t interact too well with the ordinary elitists like Frank.
It’s pretty dang tough to make the math work if you can’t generate a high savings rate to begin with, that’s for sure.
Hey Rick,
Apologies if my response came across the wrong way, that definitely wasn’t my intent. I actually feel the same frustration and anxiety you’re describing, and you captured the feeling perfectly with: “Nothing works, all my strategies are lies or useless gimmicks.”
What I’m trying to avoid at all costs is accepting something that looks like a solution to those feelings, but isn’t, something that promises certainty where none really exists.
The uncomfortable reality is that the math is harsh. Nothing fully eliminates sequence risk. In the end, the only true levers are lower withdrawals, some form of income flexibility, or accepting trade-offs elsewhere.
Where I think things get more nuanced is that while no strategy solves the problem, different approaches can change how the risk shows up, how livable it feels, and whether people can actually stick with their plan when things get uncomfortable.
I’m finding it hard to imagine where you got that idea. I think I’ve read and at least partly understood every post here over the past few years.
My takeaway has been that there’s no alternative to assuming something like a maximum + or – 4% inflation adjusted long term withdrawal rate (depending on the level of the Shiller P/E ratio at the time of retirement) if you want relatively high assurance of long-term safety.
Yup, well said!
I don’t think that is really where he is going with this.
FIRE math certainly does work, but only if you do it correctly which ERN is trying to show.
I find these posts valuable because at the end of the day, I want to simplify my portfolio and my early retirement as much as possible and so understanding the real risks and timelines involved is key.
Thanks! Yes, that’s exactly the spirit I meant. Life in FIRE beautiful. All thanks to simple, low-cost index funds.
The simple index strategy works.
I think the rebuttal of gimmicks and financial memes forces us to recognize that we have control over our spending. I.e. it IS ACTUALLY hard to retire with a $750k house, a $60,000 Shopping Utility Vehicle, a $15k per year restaurant habit, a $4k per year booze and sweets habit, all the subscriptions, a massive utility bill, a lawn service, HOA dues, and annual international vacations.
The fallacy is not in the math, it’s in our American concept that we can save enough money in a short career to burn money this quickly in a long retirement. The vast majority of us cannot.
But if we flip the script and talk about living on $50k per year, suddenly having $1.3M invested is not so heavy a lift.
And I hear your objections that this isn’t possible where you live. That’s why you need to move if you’re serious about it. And you need to ditch the 4×4 commuter truck and buy a Corolla. Those not willing to make certain choices have something to be depressed about. It’s their own decisions, not some sort of objective reality.
His recent article on momentum provided a strategy to potentially improve your withdrawal rate. Also see any of his articles on glidepaths. I appreciate the debunking articles. It gives more credence to the things he does advocate.
Hey Karsten, thanks for the update. With some preferred shares being hit lately due to lowering of interest rates, I was wondering if you’re doing anything different with your preferred shares you’ve held for your options trading account? Loss harvesting, swooping up some new shares at a discount or moving to something else all together? Thanks!
Preferred Stocks act like STOCKS.
Most of them are still in profit territory. I’ve tax-loss harvested some. i also shifted a little bit into Muni Bond Closed End Funds (NMZ, NZF, NVG).
Thanks for the response. Look forward to your update on how you performed this year with your options strategy.
Thanks for the response. Look forward to your update on how your options strategy performed this year.
Just wondering if you have had a chance to read Morningstar’s just released annual paper, Dec. 3, “The State of Retirement Income: 2025,” wherein they publish their latest SWR recommendations. Would be interested in your insights.
Yeah, I downloaded the report. I found it curious that the SWR went up to 3.9% even though the CAPE ratio is now higher than last year.
I also warn against the 5.7% plus flexibility might end in tears.
CAPE ratio is Outdated. Been hearing that for 4 years.
“This Valuation Measure Doesn’t Work, No CAP(E)”
https://www.fisherinvestments.com/en-us/insights/market-commentary/this-valuation-measure-doesnt-work-no-cape
https://zacksim.com/financial-professionals-insights/cape-ratio-says-market-overvaluedbut/https://blogs.cfainstitute.org/investor/2024/04/17/cape-is-high-should-you-care/
Don’t fall for the 1+% AUM salespeople.
besides, I’ve written about how to fix some of the CAPE ratio issues. https://earlyretirementnow.com/2022/10/05/building-a-better-cape-ratio/
What would be a reasonable portfolio starting SWR for someone who is just turning 70, just retiring now, has a 40% equity portfolio, targeting 90-95% success rate and a zero ending balance?
I think 40% equities would be a bit lean even for a 70yo. I would likely start with 60% equities, 40% in diversifying assets, i.e., intermediate bonds and or short-term assets like T-bills.
I will have to post several comments as way too topics to touch on.
Let’s Review Bill Bengen’s 2025 portfolio and his (4.7+%) SWR.The updated “standard configuration” portfolio includes 55% in stocks, equally divided among five asset classes:
11% U.S. large-cap stocks
11% U.S. midcap stocks
11% U.S. small-cap stocks
11% U.S. microcap stocks
11% international stocks
40% in intermediate-term U.S. government bonds
5% in cash, represented by U.S. Treasury bills
This broader diversification, combined with annual rebalancing, has helped lift the worst-case safe withdrawal rate from 4% to 4.7%.
Interesting that Randy L. Thurman – The All-Weather Retirement Portfolio (2022) is eerily similar:
70% Stocks: 21% LCV , 12% LCG, 14% SCV, 15% DM, 6% EM
30% Bonds: 17% Short-Interm Bonds, 7% Intern’l , 3% EM, 3% HY
SWR = 5.5% for 40 Years.
So you have 2 current Papers supporting a Diversified Sock and Bond portfolio sustaining a 5% SWR.
On to my portfolio and why.
You don’t need to school me on what Bengen intended. I know that portfolio and have simulated it and concluded that it only worked because of the early SMB alpha quirk. Without that long-gone alpha you will not sustain a 4.7% SWR. I’ve simulated it. Have you?
Randy Thurman: Another overfitted “hindsight is 20/20” futile exercise.
YES. Love Winning….Stock ETFs beating VTI….Bond funds beating AGG…
And then there’s QLENX another Non-correlated Fund that just keeps going up.
2022: QLENX (+18.8%), SPY (-18%).
Per seeking alpha 5 YR Total Return: QLENX (+230.5%), SPY (+100.7%).
QLENX (5%) is slotted in with my Stock allocation…so basically Stock allocation at 60%.
The name of the Game in retirement is Maximizing SWR=> Bigger Cash Flow.
My portfolio executes to perfection.
I doubt that your funds beat anything during your actual holding period. People like you jumping on the bandwagon of recently better performing funds will often get hurt.
Full disclosure. I retired in January 2022 at 59 after working at a Power plant on shift work during COVID. I purchased my retirement home in TN in October 2019. Sold my primary house in Jan 2022.
I had 18 months cash after sale of house. I started a small pension at 60 and another small pension at 62.
Currently withdrawing (3.5%) out of Rollover IRA to fund Income taxes, Property incomes, and vacations. Roth IRA conversions for another 4 years before SS at 67.
All stock and bond funds are Actively managed. I did not construct portfolio to mimic any one Blogger, CFP, or talking head. I read them all…
Stocks 55%-> CGDV 15%, PVAL 15%, IDVO 10%, QDVO 10%, CGGR 5%
Even split between Value and Growth. No need for SC-MC. But 20% Intern’l
Bonds 25%-> ICSH 10%, BINC, DODLX, PIRMX 5% each
Gold 7.5%-> IAU and EDGH
Commodities 7.5%-> SDCI and EDGH
Long-Short 5%-> QLENX
NO REITS, BDCs, Small-cap, MFs, CEFs, Private Credit or Equity, HDO, Leverage.
You don’t even need to wait for ERN to reply. He’s default answer to anything is – doesn’t work, too optimistic.
Sounds like Frank “golden ratio” Vasquez. Very arrogant and his way or the highway.
Frank held TLT for a (-31%) drop in 2022.
It has worked for 4 years…will work for another 40…
Someone is salty.
Best of luck. Your portfolio is overfitted. Picking the same S/B ratios but with IVV/AGG will give you the same expected results. Or maybe slightly better due to lower expense ratios.
Not Really…Per seeking alpha 10 YR Total Return: DODLX (+65.9%), AGG (+21%).
Which bond fund gave a Retiree a Bigger SWR?
I already showed how my Stock ETFs have a 30% larger Growth rate than IVV.
You’re obviously very confused and inexperienced. Again DODLX did better during a garden-variety inflationary shock. Funds like this would have done terrible in a 1929-1932 or 2000-2003 or 2007-2009 scenario. You have hindsight bias. Recency bias. I certainly wish you good luck with your retirement, but you look like an accident waiting to happen. I hope your wife is OK with this.
I find it ODD that the Author does not Eat his own cooking. He did not But Gold even though he determined Gold would increase SWR. My Take is that Gold is for Safety not Inflation. Commodities, especially Energy provides Alpha during “Increasing inflation” see 2021-2022.
2021: IAU (-4%), XLE (+53%), SDCI (+36%).
2022: IAU (-0.6%), XLE (+64%), SDCI (+33%).
We can debate how much Gold and Commodities. IMO…15% split between both is Ideal. https://www.bloomberg.com/professional/insights/commodities/the-power-of-a-commodities-allocation-a-little-goes-a-long-way/#:~:text=During%202022%2C%20commodities%20gave%20positive,a%20traditional%2060%2F40%20portfolio.https://www.morningstar.com/portfolios/commodities-vs-gold-which-is-better-inflation-hedge
Problem with commodities: passive commodity strategies (GSG, USO, UNG), suck during contango environments. Active strategies are expensive, may work for a while and then fizzle. You can always find something that worked for a while, hindsight bias, but good luck making this work long-term.
Karsten
Not Really. But depends on a Reasonable allocation and Active management. I use SDCI -> 5* / Gold rated from M*.
I limit portfolio to 7.5% of Rollover IRA. Perfect in any Market Environment. Non-Correlated to SPY.
Per seeking alpha 5 YR Total Return: SDCI (+167.9%), SPY (+100.7%).
I do not hold Long Term Bonds. Why-> see 2022. I hold actively managed Bond Funds that Crush AGG/IEF/TLT over the past 10 years.
2022: My bonds-> ICSH (+1%), DODLX (-8%), FFRHX +1%), PIRMX (-5%). Swapped FFRHX for BINC.
2022: Other bonds-> TLT (-31%), IEF (-15%), AGG (-13%).
IMO…zero reasons to hold LT bonds in retirement-> too volatile.
Per Seeking Alpha 10 YR Total Return: PIRMX (+97%), DODLX (+66%), IEF (+12%), TLT (-7%).
Good luck waiting for TLT to break even.
Proof My bonds protected my portfolio in 2022 and Beyond.
How will those funds perform in a repeat of the Global Financial Crisis when you actually need the duration effect? Not in a garden-variety market drop like 2022.
Garden Variety? QQQ was down [-33%] for the year. SPY [-18%]. Bring GFC 2 on. I have 2 years of withdrawals in ICSH and another 2 years in BINC. That is why I hold Active managed ETFs.
Well, the 33% down is at your own choosing because you’re one of the “diversified” folks who buy more ETFs than you need but only generate more volatility, not less. The S&P 500 was down much less.
And your comment about “Garden Variety? […] Bring GFC2 on” just shows what a financially inexperienced person you are. Here’s the comparison that shows how much more severe the bear markets of the 2000s were:
Dot-Com crash:
Top to Bottom: -49.1%
Days of Bear Market: 929
Days to new all-time High: 2623
Days to new CPI-adjusted High (Total Return): 4791 (13+ years!)
Global Financial Crisis:
Top to Bottom: -56.8%
Days of Bear Market: 517
Days to new all-time High: 1997
Days to new CPI-adjusted High (Total Return): 1977
2022 mini-bear-market:
Top to Bottom: -25.4%
Days of Bear Market: 282
Days to new all-time High: 746
Days to new CPI-adjusted High (Total Return): 788
https://books.google.com/books?id=RwQEAAAAMBAJ&printsec=frontcover&source=gbs_ge_summary_r&cad=0#v=onepage&q&f=false
I was in Kiplingers Magazine in October 2005.
Inexperienced?
I retired at 59. I am good.
Full disclosure I retired in January 2022. I Rolled over my 60/40 401K portfolio into my Rollover IRA. I basically held about a dozen “Dividend” Stocks and SCHD , JEPI , DIVO , JQUA. So Glad. My Stock portfolio 2022 (-3.5%). Got religion and abandoned dividend investing.
A couple of months after transitioned all stocks to ETFs. Capital Group just started their own suite of Active Managed ETFs-> CGDV and CGGR. Staggering returns over SPY since then.
I retired at age 44. I’m better.
What page are you on?
My Retirement stock portfolio holds Value and Growth stocks, no Small cap. Why? See 2022.
2022: QQQ (-31%), SPY (-18%), PVAL (-2%).
Then Growth went on a tear for 3 years. Per seeking alpha 3 YR total return: QQQ (+124%), SPY (+79.6%), PVAL (+71%).
Intern’l is 20% stock portfolio. Why? Diversify away from USD.
YTD: IDVO (+36%), SPY (+18%).
I rebalance yearly or when prudent-> Like Massacre week (April 2025).
Good. Value + Growth = Blend. That’s exactly my approach. But I don’t need to split up my portfolio into three funds because I already have everything covered with US Total Market and S&P 500.
I’m curious… aside from whether there is any meaningful difference between SP500 and “total market” funds, if I use the asset class analyzer at portfoliovisualizer for US Large Cap (Blend), US Large Cap Growth, and US Large Cap, it clearly indicates (by about a 0.5% improvement of the CAGR) that a 50-50 combination of US Large Growth and US Large Value is better than simply putting 100% into US Large Blend. I’m assuming that’s predominantly a beneficial affect of rebalancing (that you can’t do in a blended fund) + some historical over performance by value over growth. Why would you turn down that extra 0.5%–over a long period of time that’s a significant difference both in portfolio value and therefore SWR? It’s not like holding two funds is significantly more difficult that holding one? Clarification?
Edit–that’s 1972-present data: 100% US LCB (10.9% CAGR), 50%-50% US LCG/LCV (11.4% CAGR)
Noted. Same reply. I don’t believe that’s legit alpha there.
Thanks,Karsten! This saved me wasting time further diversifying my portfolio. I assume the diversification is for withdrawal protection. I don’t see real estate is mentioned. Real estate price cycle is different than equity. One creative way is to take HELOC to avoid withdrawals of equity during the downturn. What are the risks here? Thanks!
Using a HELOC to smooth withdrawals during market breaks is an interesting concept. One would have to be careful to do it according to a rule rather than as an attempt to market time, but it certainly bears thought. Why have I never heard of that before?
HELOCs or other forms of loans are risky. For a short enough bear market it may work, but then you don’t need the loan anyway. If you have a repeat of the 2000-2013 drawdown you may run out of money, though.
Real Estate is a useful diversifier. REITs are still too correlated, but physical RE is best. But it’s also illiquid.
I think that’s a fluke. At the rebalancing, a 50% LCG+50%LCV is the same as a 100% LCB. If your portfolio rebalancing is at the same frequency as the index rebalance (often quarterly or semi-annually). It’s very strange that the LCG+LCV portfolio outperforms to consistently over all rebalancing frequencies I tried. A possible explanation could be that the indexes are different, i.e., the LC index is the S&P 500 and the LCG/LCV are the Russell 1000 Growth and Value.
Also notice that most of the outperformance came before 2000. No more outperformance after 2015.
Karsten,
So basically you have 1000s of stocks and 50% are probably NOT Good Investments (Ex-> EPS growth/FCF…Congratulations.
I hold Active managed ETFs that hold 50-100 stocks that management has High conviction in.
ALL beat SPY since inception and are Top quintile in their category-> Value, Growth, and Intern’l
Per seeking alpha since CGDV and CGGR inception (2/24/2022): CGDV (+88.3%), CGGR (+84.1%), SPY (+60.6%). Actually my Covered Call Intern’l ETF has Beat SPY since inception (9/12/2022):
IDVO (+86%), SPY (+79.7%).
I would rather juggle a couple of ETFs for 30% more growth in my IRA. A Bigger IRA Balance = Bigger SWR.
Since inception, great.
Have you held them since inception? How have they done since you bought them? Example: your Kiplinger 2005 issue. If you had followed that advice about small-cap stocks (Page 32) it wouldn’t have worked. Even though since inception it worked great.
Big ERN,
Thank you for the post. I am always learning a lot from your stuff. Please don’t roast me, I just have a couple of questions as a layman trying to learn more. These questions are more geared towards a later-state accumulation portfolio vs. a distribution situation (with regards to international stocks in the portfolio). Your scatter plot clearly illustrates how ex-US is no place to hide in a bear market, that I recognize.
How should we account for the current, historically high, US valuations vs. ex-US? Sure the SP500 has cleaned ex-US’s clock since the GFC, but will that be the case over the next 10 years? The dollar was at a low point coming out of the GFC (seemingly a bad starting point for ex-US). The recent JP Morgan guide to the market was showing the previous 20 year average discount for ex-US to the SP500 is -19% (forward P/E). It shows it currently at -34%. Isn’t that a 79% discount to the average over the last 20 years? US earnings are still higher, but it seems earnings are improving internationally? Many of the large target date fund providers are slightly overweight international stocks (I assume the managers of trillions in AUM aren’t total idiots?). The dollar has been declining also. Is this not a setup for international to at least do OK relative to the US over the medium term (5-10 years)? It seems you usually favor US stocks vs. international, but is there no value in some international equity diversification at the present time?
Thank you!
I didn’t say international stocks are useless. I hold some ex-US myself. I simply stated that they are less useful than often advertised.
But I also believe that there is a fundamental flaw with some international markets: Europe? Too much bureaucracy and anti-growth policies. China? Run by Communists. Japan? Very low growth for 30+ years. So, the US is the technology and growth engine. I don’t mind being mostly in the US.
I agree with you on all of that! Thank you.
How in the world did you write this post without mentioning all the financial media articles touting crypto as a means of diversification? E.g. the somehow-common advice that everyone should own 2-5%.
I kept reading thinking “he’s going to mention scammy crypto pitches at this point… maybe next… any minute now….”
I wrote about Crypto here: https://earlyretirementnow.com/2022/04/25/crypto-is-a-bad-investment/
It’s now too correlated with equities. But I added a short note on this issue in Section 3.
Less about the correlation.
More about how diversification is used as a rationalization to chase crypto prices higher. Phrased that way, buying some Dogecoin is only a rational response to portfolio management – at least that’s how the boosters promote it.
Well, the problem is with the “boosters” and “promoters.” It’s not sound analysis.
Great article ERN. Two absolute gems for me.
1. The US/Ex-US cone graph
2. How volatility impacts diversification…I read way too much of this kinda stuff LOL. And sadly, never connected these two dots.
Thanks! Glad this was useful and new information! 🙂
ERN – Thank you for another excellent, well-researched essay. Perhaps you’ve covered this in a past post, but since Gold is presently at record highs, have you ever considered if other precious metals like Silver and Platinum could serve as effective alternative diversifiers in a bear market?
I haven’t. Certainly Gold has had a fantastic run. But so did Silver recently. YTD, Silver is up more than Gold. If you look at a long-time time series of Gold/Silver prices, it’s now back to historical average:
https://www.jmbullion.com/charts/gold-silver-ratio/?q=the%27%22()&wickedsource=google&wickedid=CjwKCAiAl-_JBhBjEiwAn3rN7TrSJ1ics11iBjlcDrIKxBSLRUUXQaDxPqcbOYm0VioQvWa4_5ycYRoCLdcQAvD_BwE&wickedid=674728931012&wcid=88956625&wv=4&gad_source=1&gad_campaignid=88956625&gbraid=0AAAAADwTUk9xBTag-Pe-rFLbowb1razLz&gclid=CjwKCAiAl-_JBhBjEiwAn3rN7TrSJ1ics11iBjlcDrIKxBSLRUUXQaDxPqcbOYm0VioQvWa4_5ycYRoCLdcQAvD_BwE
Great post. Here are a couple of additional subtleties.
1. Return variance isn’t the appropriate risk measure for most readers. For retirement funding, the most important risk is the risk of ruin: running out of money. In the extreme, if we want minimum variance we just hold cash, but this increases the risk of ruin (since low returns & no inflation protection). Similarly, Sharpe ratio isn’t the best selection criterion.
2. Though it’s the 800lb gorilla, the US isn’t the only equity market available, and (as you rightly point out) it’s hard to get much benefit of diversification here alone. In the study below we see that diversifying US equity holdings with emerging market or developed market equities is much more (often 10x more) beneficial than diversifying within US equities only.
Here’s a useful study of accumulation-phase diversification: https://www.bogleheads.org/forum/viewtopic.php?t=437186
Some of the key findings:
* Diversification benefits drop dramatically as asset count increases. Assuming assets are themselves diversified funds, then there’s little reason to diversify to more than about 4 assets.
* If you’re thinking about adding an asset to your portfolio with a 1% lower expected return, just don’t do it. Diversification rarely adds 1% to weighted average portfolio return.
* A corollary: Adding bonds will increase risk (of ruin) due to low expected returns. If you feel the need to include bonds, then use long term Treasuries, not corporate credit.
* Another corollary: if you expect US to outperform foreign (by 1% or more), just don’t add foreign.
* If you want to stay with US market holdings: then diversify by splitting VTI into pieces with as little correlation as you can. E.g. splitting VTI into “growth” and “value” slices for large/mid/small cap stocks (6 holdings) adds 34bp of diversification benefit, improving returns of VTI from 11.48% to 11.84% (over last 43 years).
* Higher variance of individual assets improves diversification benefits. We show this mathematically and with empirical results. Because of its high variance, emerging market equities are an excellent diversifier.
* Rebalancing strategy directly impacts diversification benefits (so much so that I wrote a separate thread on it.) As it turns out, there’s a difference in diversification between holding “the whole market” and owning two assets that partition the market (with occasional rebalancing), where the latter usually wins. (Taking any monolithic asset and splitting it into 1/N pieces pretty much guarantees a meaningful diversification benefit.)
* Gold doesn’t help. It’s a great diversifier, but its expected returns are so much worse than equities that it will worsen overall returns.
* Optimal diversification may differ between accumulation and decumulation. Details are in that post. Diversification (including rebalancing) can worsen portfolio performance during decumulation (which, for sufficient withdrawal speeds, mimics the effect of market downturns on the portfolio — but reasons different from the ones you mention.)
Thanks for the link. I can’t say I agree with much of it.
1: I understand that portfolio vol isn’t equal to risk of ruin in SWR simulations. I’ve written an entire SWR series about that topic and understand that it’s different. But the two are related.
2: Agree: international diversification is better than intra-US diversification because the former adds new assets, while the latter usually reshuffles assets away from US Total Market weights.
When you list “Some of the Key findings” I must say that I disagree with most of them.
The disagreements are so numerous that I can’t debunk them all. But to name one, you spread the exact fallacy I pointed out in Lie 3: higher volatility in the assets you add to the portfolio hurts their diversification benefit:
I didn’t see any mathematical proof. In fact, I provided the mathematical proof of the opposite: all else equal, the new asset provides less diversification if its vol is higher. See here again:
In other words, the slope of the vol curve at w=0 gets steeper the higher new asset sigma is.
To name another: Gold definitely helped in withdrawal simulations, see Part 34 of my series. Gold had better returns than equities since 2000. Nothing to sneeze at. I concede that we should be cautious now with those nose-bleed high prices, though.
re:
> you spread the exact fallacy I pointed out in Lie 3: higher volatility in the assets you add to the portfolio hurts their diversification benefit
Note that your formula calculates the _variance of the portfolio_. Different term. I agree that higher vol of assets usually increases portfolio vol. My comment was about the _diversification benefit_ (AKA return to diversification, AKA diversification return), which is the improvement in portfolio return (above the weighted average returns of the uncombined assets) due to diversification and rebalancing. I believe “diversification return” or “diversification benefit” is the standard term of the art here, at least in academic studies.
I didn’t copy in the math from the cited posting, so I’ll include it here. This is the formula for the diversification benefit (improvement in return) for K assets of average variance sigma^2 and average correlation rho:
diversification return = 1/2 (1 – 1/K) sigma^2 (1 – rho)
“This equation simply says that the diversification return rises as the average variance (sigma2-bar) of the securities in a portfolio rises; as the average correlation (rho-bar) of the securities in the portfolio falls; and as the number of securities (K) in the portfolio rises.”
A fuller discussion is here: https://people.duke.edu/~charvey/Research/Published_Papers/P91_The_strategic_and.pdf
Taking a step back: if you put two assets into a portfolio, then calculating expected return starts with their weighted average return (same with volatility.) They can enjoy a diversification benefit if the assets are imperfectly correlated. Without asset performance volatility there can be no diversification benefit (because periodic rebalancing has no opportunity to sell higher valued asset and purchase lower valued asset), the portfolio performs simply as the pure weighted average. I.e. at the lower bound — zero asset volatility — there can be no benefit to diversification.
(As an aside: at zero vol, diversification and rebalancing will reduce portfolio return below the weighted average return — since the outperforming asset, which would have enjoyed a momentum-like contribution to overall portfolio return, is regularly rebalanced down.)
Now: should the investor care more about portfolio vol or diversification return? They’re different, and different investors may prefer one over the other. However if you’re trying to mix assets with returns 1 and 1 to get something over 2, then an important driver of getting returns over 2 is the volatility of the assets: the higher their vol, the easier it is to get a return > 2. For most investors in accumulation phase, expected return is the driving consideration, and mixing imperfectly correlated assets, of comparable returns, and of high volatility is a good way to get there.
(If the investor’s goal is to reduce volatility — then just hold low-vol assets, like fixed income and cash equivalents. This increases risk of ruin for most investors.)
As for gold: again, in the post I cited, you can find the impact of adding gold to a VTI portfolio over the time span 1980-2023: it reduced the weighted average return from 11.48% to 7.09% — but enjoyed a .66% diversification return, raising the realized annual return to 7.75%. That’s a relatively healthy diversification benefit, but it’s overwhelmed by the poor baseline return for holding gold. In this sense it mimics adding bonds to an equity portfolio: potentially good diversification benefit, but overall a meaningfully lower portfolio return.
Unfortunately, you’re entirely in the wrong and very much confused about the meaning of the formula in the Erb and Harvey paper, specifically. And about diversification, portfolio management, and finance in general. Which, as a CFA charterholder, is mighty embarrassing.
Let me explain:
1: The formula 1/2 (1 – 1/K) sigma^2 (1 – rho) is 100% correct. It refers to the fact that arithmetic average returns translate into CAGR, but only net of a vol adjustment of 0.5 times the Variance. In the formula, in the bracket, the 1 comes from the original portfolio and the 1/K comes from the diversified portfolio with the lower variance. All 100% correct, because this comes from C. Harvey, a very well-established finance professor. I sat next to him and interacted with him at the Atlanta Fed conference in Sea Island a long time ago. Smart guy!
Here is an example: two assets, both with 15% volatility and a 0.8 correlation. Of course, the vol-minimization occurs when we pick w = 0.5. The volatility is about 77bps lower. The effect on expected returns is about 11bps. To be precise, 0.5×0.5×0.15^2×0.8=0.001125.
2: All of your analysis goes out the window if the new asset has a different volatility. If your initial asset still has 15%, the correlation is still 0.80, but the new ETF has a vol of 20%. This new ETF offers no diversification, because it increases volatility from the first percent of allocation to that ETF. And you also create a negative impact on the CAGR adjustment. So, you create the worst of both worlds: higher vol and a negative diversification return.
Your formula, which you so blindly and naively apply, does not work here. If I have an existing portfolio with vol=15% and I add a 20% vol asset, your formula is useless, unless you believe that the addition of the new asset also raises my existing portfolio’s vol to 20%, which is ludicrous.
So, in the future, please refrain from blindly copying formulas from the internet and applying them to actual financial issues when you don’t comprehend basic math, stats, and portfolio management 101. People might lose money listening to your advice.
3: Just more generally, you are extremely confused about what diversification is and isn’t. The Campbell paper points out a side effect of diversification in the form of a slight boost to the CAGR. You make return maximization the main goal of diversification, which is peak-Dunning-Kruger. Diversification is about risk mitigation, not return maximization. Yet, all the pretty bar charts in your Bogleheads post are about average returns, which is absurd. You can get away with that kind of nonsense at Bogleheads but not on my blog.
In any case, with your analysis, you’d apparently want to tell me that a 100% equity portfolio is better diversified than a 75% equity plus 25% bond portfolio because the former has a higher return than the latter. Or you’d apparently tell me that a equity 3x-leverage ETF is better diversified than a plain S&P 500 fund, because the 3x leverage has higher returns. That’s insane!
That said, we shouldn’t throw out the return-baby with the risk-bath-water, as I wrote in my post. So, I added a new section to provide a similar formula for the Sharpe Ratio. Please see the update in “Lie 5.” Still, many of the same criticism applies: Many exotic ETFs don’t improve your Sharpe Ratio either.
4: A piece of irony: the paper by Campbell didn’t age well. This paper proposed adding commodity strategies to your portfolio, right around the time of peak commodity craze. After the global financial crisis, passive commodity strategies performed terribly. So much for “diversification return.”
Source: Yahoo Finance. GSG ETF returns since 2006, when Erb and Campbell gave their commodity recommendation. Down over 50% in nominal terms. Even worse when adjusting for inflation.
5: More irony: the one commodity that actually bucked the general trend was, you guessed it, gold. You can’t make this up!
6: More generally about gold: You cherry-pick your gold return window. Conveniently ignoring the runup after 2023 and before 1980. I did a more unbiased analysis, looking at much longer windows, and found that every historical worst-case scenario cohort would have slightly benefited from a small gold allocation, which would have diversified against the major equity market meltdowns. Intriguingly, this is true both for supply and demand shocks. Of course, I’m not a big gold bug myself, and I have never allocated any serious money to this asset, but I concede that gold has been a neat diversifier. But I also fear it’s too late to jump on the gold bandwagon now.
Hi Karsten,
Very interesting post as always but I admit I’m surprised by the findings as I figured the diversification benefit of having separate blocks of value during 2000-2002 dotcom crash alone would have more than made up in SWR anything it lost during prior boom late 90’s years. Or even elsewhere But I have a question; your results seem to differ considerably from Tyler at portfolio charts where nearly always more diversification has greater SWR amounts. Do you know what would account for the difference in the results? Thank you.
Lou
Value stocks would have diversified the 2000 crash. Value dropped a lot before the crash, while the Dot-Com bubble inflated. Then value recovered when the bubble burst. I never claimed otherwise.
My results don’t differ from Tyler’s because we (mostly) use the same data series. Only our data series lengths and our interpretations differs. Tyler looks at none of the historical worst-case scenarios, because his analysis starts in 1970 and he ignores the 1960s and 1920s and 1900s worst case scenarios. By latching on to that one single retirement cohort, December 1972, he cherry-picks the best portfolio that would have saved you in that one single recession. You can do that but be aware that it’s massively overfitted and likely to no longer work because the small stock and value stock premia have now gone away.
More info:
Part 62 of my SWR series for more info. https://earlyretirementnow.com/2025/06/02/small-cap-value-swr-series-part-62/
Small-Cap Value Stocks: Diversification or Di-WORSE-fication? https://earlyretirementnow.com/2024/12/02/small-cap-value-stocks-diversification-or-diworsefication/
Thank you for your reply. I had thought any difference likely was due to differing start dates of the data set but thank you for your explanation.
One follow up question; you mentioned in your last post that a post was coming soon about RIsk Parity. Is this that post I assume? Or is another more specific to Risk Parity still to come?
Thanks again!
The separate Risk Parity piece is in the works. But with any “debunking” post it takes a lot of time.
Great article! Many thanks and greetings from Germany!
Thanks! Viele Gruesse zurueck nach Deutschland!
I appreciate you sharing this blog post. Thanks Again. Cool.
Great article Ernie! Much to think about.
For my portfolio (I’m accumulating), I’ve been mixing US tech with emerging market value. My intuition was that these should be non-overlapping enough to diversify. However, with your maths, I can test my assumption!
Correlation [PortfoliosLab; iShares MSCI EM IMI (no data for my Avantis Emerging Market Value) vs. Invesco US Tech Sector] = 0.66
Tech 5Y Sharpe = 0.87
EM 5Y Sharpe = 0.37
0.87 * 0.66 = 0.57 (which is > 0.37)
Therefore I shouldn’t bother adding EM to diversify! Hmm. Even giving EM value a 20% return premium wouldn’t be worth it. I guess markets are simply too correlated.
I would be very interested in seeing a “Lie 4 funnel plot” for SPY vs. EM and SPY vs. China!
Best wishes for 2026!!
EM had a challenging time: low returns and high risk. From a Sharpe Ratio point of view, this is an uphill battle.
I have a somewhat random and possibly silly question: what do you use as the portfolio value at retirement, both generally and specifically in the SWR toolbox spreadsheet? What I mean is: one day you could look that spreadsheet and have it say that 3.5% is, for you, an acceptably-safe SWR. Accordingly, you decide that you can withdraw 35k per year of your one million dollar portfolio. But the next day there could be correction and now you only have half a million dollars, or a 17k per year still at 3.5%. But unless I’m very mistaken, the previous 35k already accounted for the possibility of a correction, and so the 35k was presumably safe. Am I missing something in this logic? Is the “safe” portfolio value to be used the peak portfolio value?
No, you don’t have to adjust the new withdrawal amount. The old $35k amount was safe already and robust to a drop like the Great Depression.
Many thanks.
My understand is that you could go the opposite way though, right? So if the market does reasonably well for some period of time after you retire your SRW calculation could go up and you could use this new value going forward?
Correct! That’s the most likely scenario, too!
Well, yes and no. The SWR was calculated based on the assumption of withdrawing the constant amount, not increasing it if the first years go well. If you recalculated the fail chance using this strategy, you should get worse results than expected (e.g. SWR was 4% for 95% chances, but you actually get 91% only).
That said, the effect shouldn’t be too large, as the best performing sequences (especially the ones performing well early on) are least likely to fail anyway. So most of them would be fine even with the increased withdrawals. But the odd exceptions would probably shift some of the probability mass around.
I’m not entirely sure that is true, but the easy answer is to simply use the zero percent failure rate. That will allow to slowly up your withdrawal rate in times when the market is not tanking. You will never have to adjust down even if the SRW falls below the previous (by definition this will mean the market is not at peak). My guess is this methodology will have you finishing much closer to your final target value than if you never adjusted from your initial withdrawal rate.
The prior comment and my reply referred to the ratcheting strategy. There is no assumption, neither implicit or explicit that rules out increasing the withdrawal amount “if the first years go well,” so your claim in the first paragraph is false.
I also disagree with the claims in the second paragraph. Have you simulated any of this?
Interesting read. Diversification is talked about a lot, but it’s true that many people misunderstand what it actually does and doesn’t do. Looking forward to the rest of the series.
Thanks! Glad you found this helpful!