is diversification needed in TSP portfolios

Q&A: Does diversification require being invested in all the TSP funds, including the I fund?

Question

Stephen,
Thanks for your class on the L funds and how the I fund is inefficient. After thinking about it, I don’t recall anyone asking about diversification. One of the benefits of the L fund is diversification. I know you can do that yourself, but isn’t having coverage in all sectors, including the International fund (I fund) a good thing?

Answer

Great question!
The short answer is diversification is not taking random shots in the dark and investing in whatever asset is under the sun. It’s more strategic than that.
In class I discussed diversification. Remember positive vs negative correlation? We don’t want positive, we want negative or non-correlation.
So, not all diversification is good.
And, recall, the end goal of diversification is to shrink the range of deviation. (i know, technical jargon).
If you have 2 assets with same return but one has wide-deviation, the other has narrow-deviation, the narrow deviation will serve you better.
So, if the I fund has a lower return than, say, the F fund, and the deviation of the I is radically wider than the F fund, and the goal of diversification is to shrink the deviation, why would I chose the I fund?

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