When talking about constructing an investment portfolio, you’ll often hear about diversification and buying low-correlation or non-correlated assets.
- A positive correlation means that the assets tended to move in the same direction. A value of 1 is perfect positive correlation.
- A negative correlation means that they tended to move in opposite directions. A value of -1 is perfect negative correlation.
- A zero correlation means that they had no relationship.
Morningstar recently released its
The lower the correlation between asset classes (the less they move in the same direction), the greater the reduction in volatility you get by combining assets. As long as you combine asset classes with correlations below 1, you get some degree of volatility reduction. This M* chart from the paper helps you visualize this:
This handy M* table shows how the 5-year correlations between the total US stock market and other major asset classes have changed over the four separate periods of 2001-2005, 2006-2010, 2011-2015, and 2016-2020:
Some quick takeaways:
- The best portfolio diversifiers for US stocks has consistently been US Treasury bonds. Short-term, medium-term, long-term Treasuries all have consistently negative correlations to US stocks. (There is some problem with the shading in the chart that doesn’t quite match the numbers.)
- International developed country stocks, Emerging Markets stocks, and US REITs have high correlations with US stocks (which is somewhat expected), but the correlation is still below 1 (roughly 0.80 or so) such that it still offers a little diversification benefit over time.
- High-yield “junk” bonds are highly-correlated with US stocks. They are just as highly-correlated as international and emerging market stocks.
- Gold has been a pretty good and consistent diversifier as well, but only on par with cash (T-bills) not as good as US Treasuries. You just need to believe that the long-term return of gold is high enough to warrant inclusion. These days, gold actually looks better to me than in the past because I figure it will match inflation, and that’s actually better than most cash and bonds right now.
“The editorial content here is not provided by any of the companies mentioned, and has not been reviewed, approved or otherwise endorsed by any of these entities. Opinions expressed here are the author’s alone. This email may contain links through which we are compensated when you click on or are approved for offers.”
Copyright © 2004-2021 MyMoneyBlog.com. All Rights Reserved. Do not re-syndicate without permission.