Bonds AND Stocks: Why Correlations Matter!

Source: Morningstar

Bonds AND Stocks: Why Correlations Matter!

There is an old saying that hindsight is 20/20. That saying has never been more true than when looking at the past results for an investment strategy. I often joke with one of my meteorological friends that if they ever get sacked for making a bad weather forecast, they would be welcomed with open arms into the investment world. That is because it is SO difficult to predict when one asset class (or strategy) will outperform another. Hence the usual disclaimer: "Past performance is no guarantee of future results." So, what is an investor to do? Sit on the sidelines in cash? While that may be a viable strategy for a short period of time, it would have been devastating to your wealth if you had pursued that strategy (shown above in black and labeled Strategy F) over the last 90+ years.
“A ship is safe in harbor but that’s not what ships are for.”
– William Shedd
While Strategy F would have never really "lost" any money for you, its purchasing power would not have given you much of a cushion over inflation during the last 90+ years. Strategy A - on the other hand - would have rewarded you for your high risk exposure during your lifetime. The big challenge of following Strategy A would have been not getting sea sick from the terrible gyrations in value over the first 20 years of your life. That is where this whole idea of correlation comes to our rescue. When we combine two (or more) strategies together, our course toward wealth can be smooth enough that we do not "jump ship" right when our fortunes are about to change for the better.

Pilots on planes have checklists for when something goes haywire. Cooks have recipes for meals they serve only once a year. Here is my simple advice for you to find your island in the vast expanse of the open seas.
  1. Think LONG term. Not days. Not months. Not even years. Think DECADES!
  2. Accurately assess your risk tolerance. Invest up to - but not above - it.
  3. Allocate your assets between NEGATIVELY correlated strategies.
  4. IGNORE news of the crisis du jour - there is always one.
  5. Only worry about things that YOU can control.
“Twenty years from now, you will be more disappointed by the things you didn’t do than those you did. So throw off the bowlines. Sail away from safe harbor. Catch the wind in your sails. Explore. Dream. Discover.” – Mark Twain

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