Bryan wrote:
Right, but if you want to reduce the SD of your return, you've got to
square those numbers - you need 100 stocks to get the SD down by 90%.
And isn't that the measure of risk most people vaguely have in mind?
>>>Well what I suppose we should be using isn't either the SD or the Var, but the % of
>the maximum increase in utility that is possible with increasing diversification.
>Playing around with a few examples it looked to me that the gain in utility was
>inversely proportional to the decline in variance - - not the SD. However, more
>surprising than that was the incredibly small utility gain that one obtains by
>reducing the standard deviation of your income from say 20% of the mean to 10% of the
>mean. In all the examples I worked out a .1 or .2% increase in the rate of return
>completely dominated that.
In any case, I'd like to thank Bill for the only useful investment
information I've learned since the JEL piece on international
diversification.
>>>Your welcome. Just note that this was never intended as investment advice, your
>milage may vary, not doing exactly what someone else told you to do will certainly
>cost you your life fortune and leave you broke and starving, its not my fault, repeat
>PLEASE DON'T SUE ME!
So Bill, if you had to guess, roughly what expected return reduction
would you get from (a) standard stock-picking and active trading, (b)
managed mutual funds, (c) index funds, and (d) buy and hold with
discount brokers? I would still guess that (c) closes 90% of the
distance between (a) and (d), but I'd like to hear your guesstimate.
>>>Depends on the size of your portfolio. If its $2,000 you might very well be better
>off with the mutual fund. With a million dollars or more I expect that 90% is almost
>exactly right (figure zero percentage costs vs. annual costs of .5% of your current
>net worth in present value terms for 20 years). I use the .5% figure rather than the
>.17% or .2% figures for the reasons I mentioned in a previous post plus one more I've
>thought of since then. If you buy individual stocks you are likely to have some
>losers. You can sell those to take capital losses that you can use to reduce your tax
>liability for your unavoidable investment income (dividends and interest on fixed
>income assets). Can't do that if you diversify in a mutual fund. - - Bill
Prof. Bryan Caplan
Department of Economics George Mason University
http://www.bcaplan.com [EMAIL PROTECTED]
"He wrote a letter, but did not post it because he felt that no one
would have understood what he wanted to say, and besides it was not
necessary that anyone but himself should understand it."
Leo Tolstoy, *The Cossacks*
