Non-correlation of investment assets
may seem to be complicated, but it is very important to the long-term success
of an investment portfolio. To understand non-correlation, we must first
understand what we mean when assets are correlated. Investment assets are
referred to as being highly correlated when they show a tendency to vary
together. For example, U.S. stock classes--large, medium and small-- tend to
increase and decrease in value together. For many years, large international
stocks were not considered to be correlated to U.S. stocks, but they are now
92% correlated. Bonds are not correlated to stocks. Bond groups--investment
grade corporate bonds, U.S. Treasury bonds and municipal bonds--tend to be
highly correlated. Stocks and bonds are not correlated and therefore each moves
in its own manner. The importance of including non-correlated assets in your
investment portfolio is to reduce investment risk. Bonds, stocks, real estate,
emerging market investments, and commodities are non-correlated. By mixing
these various non-correlated asset classes, your portfolio is not as likely to
be whipsawed, up or down, by the volatility of one particular class of assets. While this strategy is helpful in most instances, it is not
foolproof. On the other hand, including asset classes that are non-correlated
doesn’t prevent them all, or most, from moving up or down at the same time. In
2008, we saw an example of non-correlated assets all moving down together, as
the U.S. and world economies went through a terrible economic period. This is
the exception and not the norm, but illustrates what can happen. For this
reason, I believe that a static portfolio, one that sets an allocation of
non-correlated assets that does not change, can be detrimental to your
investment wealth. Depending on the state of the economy and other relevant information,
raising or lowering the percentages of various non-correlated assets can be
useful, and is an active asset management style.
Ed
Mallon
