In our last article “How Risky Are My Investments? Part 1” we discussed what is meant by the “risk” of an investment portfolio. We ended the article with the question, “How do we reduce risk without compromising return?”
One of the best ways to reduce uncertainty and risk without compromising returns, is to reduce the correlation of all of the investment assets inside the portfolio. Correlation means that two investments have similar results and outcomes (even though they have a different name on paper). Let’s give an example…
If the S&P 500 goes up by 10% and my investment portfolio ALSO goes up by 10%, we would say that my portfolio and the S&P 500 have a high correlation. We would say that what impacts the S&P 500 also similarly impacts my portfolio.
If the S&P 500 goes down by 10% and my portfolio ALSO goes down by 10%, it is further evidence that my portfolio and the S&P 500 are strongly correlated. Correlation to segments of the market are fine when those markets are good. It’s not so great when these market segments are bad and losing money. In bad markets I don’t want correlation, I want diversification.
Diversification means that the different pieces of my investment portfolio act differently (not the exact same direction) in a market environment so that when one’s zigs the other zags. It provides more stability and consistency, especially in rough markets.
Diversification is achieved by choosing assets inside a portfolio that are not strongly correlated to each other.
Each asset type (US stocks, international stocks, bonds, real estate, commodities) has a level of correlation with another asset and can be measured. A correlation umber of 1.0 means the 2 investments are the same. A correlation number of 0 means that there is no correlation. A correlation number of -1 means that they act in exactly the opposite direction. Two investments can have a correlation number anywhere along the spectrum. Here is a visual example of correlation of different types of assets:
The asset correlations in the red boxes indicate the assets that are considered highly correlated, relatively the same results in the same market. They provide little levels of diversification when combined. The asset correlations in the white boxes indicate assets that are lowly correlated and provide moderate levels of diversification. The asset correlations in green boxes indicate assets that are not correlated and provide the highest levels of diversification.
Of course the 7 assets listed on the correlation matrix only represent a small number of investment assets available to use in a portfolio. There are many others.
Creating a portfolio of low to no correlation of assets provides the highest levels of diversification during choppy bear markets.
A portfolio can be fairly easily measured in regard to the level of risk and the level of correlation/diversification. We use Morningstar software to provide this information to us about a portfolio.
If you would like a free Morningstar report on the level of portfolio risk and correlation for your portfolio, please reply to this email with the subject “PORTFOLIO REPORT” and I can get you the details. There is no cost or obligation
In our last article “How Risky Are My Investments? Part 1” we discussed what is meant by the “risk” of an investment portfolio. We ended the article with the question, “How do we reduce risk without compromising return?”
One of the best ways to reduce uncertainty and risk without compromising returns, is to reduce the correlation of all of the investment assets inside the portfolio. Correlation means that two investments have similar results and outcomes (even though they have a different name on paper). Let’s give an example…
If the S&P 500 goes up by 10% and my investment portfolio ALSO goes up by 10%, we would say that my portfolio and the S&P 500 have a high correlation. We would say that what impacts the S&P 500 also similarly impacts my portfolio.
If the S&P 500 goes down by 10% and my portfolio ALSO goes down by 10%, it is further evidence that my portfolio and the S&P 500 are strongly correlated. Correlation to segments of the market are fine when those markets are good. It’s not so great when these market segments are bad and losing money. In bad markets I don’t want correlation, I want diversification.
Diversification means that the different pieces of my investment portfolio act differently (not the exact same direction) in a market environment so that when one’s zigs the other zags. It provides more stability and consistency, especially in rough markets.
Diversification is achieved by choosing assets inside a portfolio that are not strongly correlated to each other.
Each asset type (US stocks, international stocks, bonds, real estate, commodities) has a level of correlation with another asset and can be measured. A correlation umber of 1.0 means the 2 investments are the same. A correlation number of 0 means that there is no correlation. A correlation number of -1 means that they act in exactly the opposite direction. Two investments can have a correlation number anywhere along the spectrum. Here is a visual example of correlation of different types of assets:
The asset correlations in the red boxes indicate the assets that are considered highly correlated, relatively the same results in the same market. They provide little levels of diversification when combined. The asset correlations in the white boxes indicate assets that are lowly correlated and provide moderate levels of diversification. The asset correlations in green boxes indicate assets that are not correlated and provide the highest levels of diversification.
Of course the 7 assets listed on the correlation matrix only represent a small number of investment assets available to use in a portfolio. There are many others.
Creating a portfolio of low to no correlation of assets provides the highest levels of diversification during choppy bear markets.
A portfolio can be fairly easily measured in regard to the level of risk and the level of correlation/diversification. We use Morningstar software to provide this information to us about a portfolio.
If you would like a free Morningstar report on the level of portfolio risk and correlation for your portfolio, please reply to this email with the subject “PORTFOLIO REPORT” and I can get you the details. There is no cost or obligation
In our last article [link the words last article to the article], we discussed what is meant by the “risk” of an investment portfolio. We ended the article with the question, “How do we reduce risk without compromising return?”
One of the best ways to reduce uncertainty and risk without compromising returns, is to reduce the correlation of all of the investment assets inside the portfolio. Correlation means that two investments have similar results and outcomes (even though they have a different name on paper). Let’s give an example…
If the S&P 500 goes up by 10% and my investment portfolio ALSO goes up by 10%, we would say that my portfolio and the S&P 500 have a high correlation. We would say that what impacts the S&P 500 also similarly impacts my portfolio.
If the S&P 500 goes down by 10% and my portfolio ALSO goes down by 10%, it is further evidence that my portfolio and the S&P 500 are strongly correlated. Correlation to segments of the market are fine when those markets are good. It’s not so great when these market segments are bad and losing money. In bad markets I don’t want correlation, I want diversification.
Diversification means that the different pieces of my investment portfolio act differently (not the exact same direction) in a market environment so that when one’s zigs the other zags. It provides more stability and consistency, especially in rough markets.
Diversification is achieved by choosing assets inside a portfolio that are not strongly correlated to each other.
Each asset type (US stocks, international stocks, bonds, real estate, commodities) has a level of correlation with another asset and can be measured. A correlation umber of 1.0 means the 2 investments are the same. A correlation number of 0 means that there is no correlation. A correlation number of -1 means that they act in exactly the opposite direction. Two investments can have a correlation number anywhere along the spectrum. Here is a visual example of correlation of different types of assets:
The asset correlations in the red boxes indicate the assets that are considered highly correlated, relatively the same results in the same market. They provide little levels of diversification when combined. The asset correlations in the white boxes indicate assets that are lowly correlated and provide moderate levels of diversification. The asset correlations in green boxes indicate assets that are not correlated and provide the highest levels of diversification.
Of course the 7 assets listed on the correlation matrix only represent a small number of investment assets available to use in a portfolio. There are many others.
Creating a portfolio of low to no correlation of assets provides the highest levels of diversification during choppy bear markets.
A portfolio can be fairly easily measured in regard to the level of risk and the level of correlation/diversification. We use Morningstar software to provide this information to us about a portfolio.
If you would like a free Morningstar report on the level of portfolio risk and correlation for your portfolio, please reply to this email with the subject “PORTFOLIO REPORT” and I can get you the details. There is no cost or obligation.
