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Am I really diversified?

 In the book A Random Walk Down Wall Street author Burton Malkiel argues that the stock market is, as the title suggests, a random walk. In the book, which is cited and echoed by famous industry titans like Jack Bogle of Vanguard fame, it:

1. Makes little sense to think that you can beat the market. Indeed, on average you'll lose money when picking stocks.

2. In looking at when to invest and cash out of stocks, if you try to time the market you'll inevitably do worse. 

This advice really stuck with me and I still believe this to be the case. But in the current environment, as many smart people do, I do find myself asking myself if it is different this time. Much of this is due to the performance of "broad market" indices.

Diversification is the idea that by spreading your investment over many companies, you lower the volatility. You might have less upside, but you also have less downside risk. In the end, you're hoping the market as a whole does well, more than any individual stock.

I echo the sentiments of many people who think that the market seems to be disconnected with reality. In the midst of the pandemic, indices like The Dow Jones Industrial Average had phenomenal results even while the market was shut down and we believed that there were no viable vaccines. The market plunge in March 2020 did not last long. And that run up has continued.

Indeed when considering the constituents of the S+P 500, more than 15 percent is in just three companies. 

So, if you believe the advice of titans, what does that mean about owning index funds that are based off of highly concentrated indices? In a world of high volatility where dramatic swings have such an impact on the constituents of market cap weighted indices, I think it is worth considering whether or not you are truly diversified if your goal of diversification is to take a slightly lower return as an exchange for less downside risk. 

Personally, I have several mutual funds, but when I compared them, there was a high degree of overlap in their top holdings. While I believe the advice of titans, I don't know that all mutual funds are truly providing the diversification that I thought I was getting. I did my rebalancing with this in mind and chose funds that met similar goals for my long term investing plan and adjusted during my rebalance to those funds to reduce the overall exposure to these large S+P names. 

Bulls will say that these stocks will do exceedingly well into the future, enough to justify these high ratios. I wouldn't bet against them, but for me, having a large chunk of my investments in companies that are so tightly linked feels riskier than I'd like. Couple that with the high ratios, and I was happy to rebalance.

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