Diversification Summary

Spread capital across asset classes that behave differently, plan on a horizon measured in decades, and do not sell into a drawdown. Everything above is elaboration on those three sentences; what follows is the checklist.

• Construct a portfolio with positive-expectancy assets that exhibit low mutual correlation. When equities sell off, defensive sleeves stabilize total portfolio equity.
• Focus on the overall behavior of your portfolio instead of analyzing assets in isolation. Each asset class must serve a distinct purpose — return generation, inflation defense, or volatility dampening — without redundant factor overlap.

• Maximize your long-term returns by using tax-advantaged accounts such as IRAs and Roth IRAs. Place assets by their tax efficiency:

  • Bonds and REITs are tax inefficient and do not grow like stocks, so hold them in tax-advantaged accounts to shield their returns from immediate taxation.
  • Broad stock index funds are tax-efficient — low turnover, mostly qualified dividends, gains deferred until you sell — so they are the natural residents of the taxable account; spend the scarce tax-advantaged space on assets that need the shelter.
  • Funds vary in their tax efficiency, so asset placements affects total return.
  • The most important⁷⁶ determinant of asset location is the proportion of returns distributed annually as income and capital gains.
• Avoid adding arbitrary assets to your portfolio. Each addition should have a clear purpose and fit within the overall strategy, adhering to the law of diminishing returns.
• Strive to cover the entire market in your portfolio, but consider tilting towards specific segments like US small cap value or ex-US small cap to potentially improve returns.
• Minimize performance drag by choosing low-cost (low expense ratio) index funds or ETFs that passively track broad market indices instead of high-cost active funds.
• Regularly rebalance your portfolio by directing new contributions towards underperforming assets (“buy low”) to maintain your intended risk profile. Preferably, conduct rebalancing in tax-advantaged accounts to avoid taxable events.
• Adopt a long-term investment approach by buying index funds and holding them indefinitely, avoiding the pitfalls of trying to time the market.