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I was wondering why this site (and many ppl on this board) say put %100 of your money in the SP 500 fund. Wouldn't it make more sense to diversify this? Say %75 S&P, %10 "guaranteed" funds, %15 Europe? Maybe throw %1-5 in a small cap fund?

I know the S&P 500 funds offer diversification, but shouldn't it be safer to do more?
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100% in the S&P 500 is not a sound investment strategy. The S&P is a weighted index so if you invest $500 you don't have $1 go to each of the 500 stocks in the index. You will have $7 in the largest then 6$ in the next few adn so on down the line. The S&P does well if Large Caps are doing well, particularly the 10 largest large cap sionce they control almost 20% of the indexes weighting, thats not much diversification at all now is it. A better strategy would be a total market index as well as other indices. Such as the Small Cap Index, International Index, Bond Index etc.
Then you can get into the debate over whether activelyt managed funds have a place in your portfolio or if should be just comprised of indexes. Thats a debate that can go on for a while.
I happen to feel there is always some need to have actively funds in the portfolio, especially in bear markets.
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You still have to deal with the traditional TMF finding that over time S&P Index funds tend to outperform managed funds and hence are preferred because they are low cost in terms of management fees, trading costs, and capital gains distributions.

Also, international diversification has been discredited. It used to be that economies in other parts of the globe were insulated from the US economy. So you could diversify by playing the lead lag factor. Not any more. Modern electronics seem to have eliminated the hedge. Besides, why would you invest in Europe? They have mature, low growth economies and major problems with high social costs and entrenched labor unions that will resist any change. Their growth opportunites are in Eastern Europe and the third world, the same ones of interest to global US companies. Go visit a place like Mexico City. You will find all major global players there--fighting for market share. I would not say Europe has any particular advantage.

In theory managed funds can do better in a bear market than index funds (because index funds are stuck buying certain stocks even though their prospects may not be particularly good at the moment). In practice, if you check the data for recent downturns, I think you will find that does not work. Managed funds usually miss the market bottom. Even the pros are not good at market timing. Index funds still out perform.

TMF would not usually recommend guaranteed funds as an investment. Recently they have done well compared to stocks. Recently gold stocks have done well. Long term, stocks offer better returns. Fixed income investments are usually recommended for those close to retirement who will need the funds in the nearterm future. Then Fools would recommend a laddered maturity bond portfolio covering 5 years of living expenses.

For young investors, stocks are usually a better investment. Of course there are those who are saying stocks will take years to recover and we may be in for mediocre performance for some time to come. In that case, fixed incomes could be a better investment, but now you are into market timing again. Its difficult to do that right.
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I think that diversification within a 401(k) should be aproached with an asset allocation strategy as much as possible. A 100% investment in an S&P 500 fund may be diversification among large cap equities, it most certainly is not 401(k) portfolio diversification.

Our 401(k) includes a money market (guaranteed) feature, bonds, equities divided among large, small, growth and value, international stocks, and real estate. This is a fairly decent mix of asset types. The general theory would involve building the portfolio so that it includes assets that have a low correlation to each other. That is that historical returns for these assets have shown a tendency to move in opposite directions. The result would tend to smooth out the bumps in volatility while keeping returns pretty much intact. An example of two asset types generally having a high correlation would be a large cap equity and a small cap eguity. An example of two asset types generally having a low correlation woulb be large cap equities and real estate.

Regarding pauleckler's comments on international equities not being a good diversivication choice for US equities, I agree that as time goes on these two groups seems to be moving more and more in step with each other. More so than they had in the past. I still believe, however, that they are a better diversification choice for say, large US equities than US small equities.

A caveat. In most cases best results for investing outside a 401(k) type account would be some type of focus portfolio where companies are chosen one by one on the basis of a margin of safety between intrinsic value and market price. This is true since there is more freedom for the investor to determine which investments provide this margin of safety outside the 401(k) rather than inside the 401(k) due to the limited say the investor has in what the mutual funds invest in.
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Regarding pauleckler's comments on international equities not being a good diversivication choice for US equities, I agree that as time goes on these two groups seems to be moving more and more in step with each other. More so than they had in the past. I still believe, however, that they are a better diversification choice for say, large US equities than US small equities.

I wish I could remember where it was that I saw it but there is an interesting graph showing correlation of US equities (S&P500 I think) with EAFE. What was shown was that the correlation hasn't been monotonically approaching 1 over time but had moved in cycles. This strongly suggests that international equities can and do have a good diversification effect. The chart may have been in one of Bernstein's books (either one William or Peter) or maybe it was somewhere else. Anyone?

Hyperborea
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Hyperborea,

Yes, you are quite correct. Bill Bernstein's "The Intelligent Asset Allocator", is a very good choice for someone who has a good plan and wants to invest intelligently.
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Greetings Hyperborea:
I wish I could remember where it was that I saw it but there is an interesting graph showing correlation of US equities (S&P500 I think) with EAFE. What was shown was that the correlation hasn't been monotonically approaching 1 over time but had moved in cycles. This strongly suggests that international equities can and do have a good diversification effect. The chart may have been in one of Bernstein's books (either one William or Peter) or maybe it was somewhere else. Anyone?

Jeremy Siegel, in his book 'Stocks For The Long Run', has a graph comparing the two. The first link will is a site that has a lot of data from Siegel's book. Skip to page 16 (this is a PDF file, BTW) to view the start of a few graphs measuring the correlation coefficient between U.S. and other market returns, see:

http://bpaosf.bpa.arizona.edu/~ruscher/Brinker%20Cap%2001%2002.pdf

The next one has a graph which measures this as well on page 2 from 1970-2001:
http://www.acadian-asset.com/docs/Intl_Divers_2001.pdf

As an observation, the data seem to indicate that the correlation, while fluxuating, has trended in an increasing pattern over this period. I'll still maintain a small percentage of int'l exposure for now (small meaning 5% of assets). Hardly a bold move. ;-)

HTH

Bookm

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100% in the S&P 500 is not a sound investment strategy. The S&P is a weighted index so if you invest $500 you don't have $1 go to each of the 500 stocks in the index. You will have $7 in the largest then 6$ in the next few adn so on down the line.

It's worse than that. GE and Microsoft were 4% to 3.5% of the index (each) last time I checked. So, of the $500, MSFT and GE would be at $17 to $20.

The S&P500 can be the biggest chuck of your asset allocation if you're going for growth, i.e., accumlating assets (vs., say, protecting/withdrawing). However, that only gets you large-caps. You also need small cap US stocks, and international stocks, plus cash and/or bonds to be truly diversified.

I don't go for the "5% in real estate or emerging markets" idea, since that's just in the noise ratio. You have to double your 5% position to make up for a 10% change in your 50% position.
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