A short version of my question -
What is the "true" definition of a diversified portfolio and why is it better?
A long version of my question -
Regarding portfolio diversification, people generally refer to a portfolio that is all-encompassing: large-cap, mid-cap, small-cap, fixed-income, commodity, international markets (and many other types of investment), as the general arguments have been that different financial assets may perform differently under different economic environments/financial situations.
However, studies found that there is a high correlation among the performance of stocks of different cap sizes and a high correlation of stock and "alternative investments" (e.g. The Only Guide to Alternative Investments You'll Ever Need by L. Swedroe and J Kizer). In addition, considering an average investor in the US (medium US household income: $61,372) for example, who manages to save $10,000 a year for investment, there is not that much money to spread around different assets. If I were to take various index funds (see below) to calculate the return, this is what I get:
(a) the difference in the 1-yr short-term return is ~ $1,622 (equity & bond) or $444 (equity only).
(b) the difference in the 10-yr "long"-term return is $14,652 (equity & bond) or $1,225 (equity only).
Based on the numbers (and based on the feedback from other members)
is investing in one index sufficient to be considered "diversified enough"
does it add MORE VALUE (in return) to spread the "limited" amount of investment fund (i.e $10,000 in this case) into multiple indices? From the perspective of potential gain/loss, it seems no. Is this correct?
Vanguard 500 Index Fund Investor Shares (VFINX):
17.74% (1-yr); 17.15% (3-yr); 13.79% (5-yr); 11.83% (10-yr); 11.17% (since inception)
Vanguard Mid-Cap Index Fund Investor Shares (VIMSX):
13.3% (1-yr); 13.66% (3-yr); 11.53% (5-yr); 12.27% (10-yr); 9.97% (since inception)
Vanguard Small-Cap Index Fund Investor Shares (NAESX):
16.57% (1-yr); 16.20% (3-yr); 11.34% (5-yr); 12.21% (10-yr); 10.8% (since inception)
Vanguard High-Yield Tax-Exempt Fund Investor Shares (VWAHX):
1.52% (1-yr); 3.57% (3-yr); 4.85% (5-yr); 5.55% (10-yr); 6.45% (since inception)