SEED recognizes the uniqueness of every investor and the resulting required flexibility for true diversification.
Simply put, the more investments, the less idiosyncratic risk to the overall portfolio. The less correlated those assets are with each other, the less overall volatility in the portfolio. As is consistent with Modern Portfolio Theory, SEED tries to maximize after-tax returns while minimizing volatility, and as such, we strive for maximum diversity. But trying to achieve return-versus-volatility nirvana is futile. Aware that each additional, low correlated asset lowers volatility, we also recognize the incremental benefits of each additional investment quickly becomes trivial. Certainly after a point, the pursuit of lower volatility shouldn’t supersede the quest for lower taxes and fees.
From a purely academic perspective, the starting point for asset allocation should be the overall market portfolio, not just domestic stocks, but international stocks, bonds of all sorts, real estate and other alternative investments. As best as anyone can measure, the resulting 90+ trillion dollar market portfolio would comprise of only 36% stocks, the majority being international. No investor, of course, actually tries to mimic this portfolio. Most have a bias towards their domestic markets, limited access to alternative investments, try and avoid paying taxes, and skew their investments away from products they feel subject them to risks they’d otherwise like to avoid. More, investors should also try to diversify away from both the assets they already own and their often largest asset: their own human capital.
The important point is that maximizing diversification is theoretically sound, but trying to gain exposure to every asset class and every stock is not if it adds to an investor’s costs, subtracts from maximum tax efficiency, and fails at diversifying away the risk tied to their own capacity to earn income or legacy assets. The correct diversification also matches an investor’s likely cash flow needs in the future and tolerance for taking the risks to achieve those goals. That often means departure from a full market capitalization weightings for every asset akin to most index funds. This type of customized diversification is our focus at Seed Wealth Management, Inc. and is not so readily achieved from firms limited to investing in just index funds.
For further expansion of these ideas and how it applies to asset allocation and within the three major asset categories, see the links below.