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I have been talking with someone who has software that analyzes correlations of assets. He ran the "ultimate portfolio" through his system and this is what he told me

"Anyway, here's a summary of my analysis of the Ultimate Buy-and-Hold portfolio:

I used all of the DFA funds with the exception of the emerging markets fund; it's only been around since May, '05 so I used the Vanguard emerging markets fund instead. I grabbed a Fidelity short-term US Treasury fund for the bond portion and ran two analyses: one using five years of historical data and one using ten years.

In each analysis I looked at the average correlation of monthly returns of each security with the others in the portfolio, and how the recommended portfolio compared to the efficient portfolio at the same level of risk.

The average correlation for the bond fund was very low, as expected: -27% for 5 years, -22% for 10 years. The average correlations for the equity funds were very high, as expected: from +62% to +74% for 5 years, from +53% to +64% for 10 years. These numbers are far too high to provide much useful diversification.

For the last five years, the average (annual, compounded) return for the recommended portfolio was 12.88%; the efficient portfolio at the same level of risk would have returned 19.26%. Over the last 10 years, the recommended mix gave 9.41%, while the efficient portfolio at the same level of risk produced 11.14%.

Over the last 5 years, four of the nine recommended equity funds provided no useful diversification; over the last 10 years, two
of the nine."

SO, it's back to the drawing board for me. I will take away from the Merriman article the fact that short term bonds are better than mid or long term and that holding a diversfied basket of equities is a good thing however it seems as though JLC may be right, I may be able to get the balance I'm looking for with fewer than 10 funds.
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