Asset correlation is a concept of critical importance to a retirement investors. I have spent a lot of my own time studying correlations as they pertain to our retirement portfolio. I have found a new online tool that makes this job easier. First, a brief refresher on the subject.
A correlation of 1.0 does not mean that two asset classes have the same volatility or that they will always change in value at the same rate. It means that the valuations always move in the same direction.
The concept of asset correlation is a core principle in modern portfolio theory. A portfolio that incorporates asset classes that are highly correlated may be too volatile for retirement because if the stock market falls, everything in your portfolio is likely to fall with it. This can also happen in a “black swan event” when economic conditions are so extreme (or sellers or so panicked) that everything falls together. (Hello 2008!)
The bottom line is that it is helpful if not essential for every retirement investor to have some understanding of how the assets in his or her portfolio are correlated. There is a new site Asset Correlations that will assist you in learning this.
The site home page presents a matrix of correlations between different asset classes and investment indexes. This provides excellent guidance on selection of general types of investments that are non-correlated (move independently). The matrix is also color-coded to indicate degrees of portfolio diversification.
I’m not sure I agree with a strong negative correlation as indicating “excellent diversity.” I’m more interested in having strong performing assets that are not correlated at all, i.e., a correlation coefficient near zero. Those are hard to find but you need at least some in your portfolio. One example shown in the matrix are TIPS which are generally non-correlated with all other asset classes excluding U.S. bonds. (Yet another reason to own them.)
An even better feature of the site is the ability to upload your own portfolio and generate a correlation matrix based on your holdings.
If you want to compare the “risk vs. return” characteristics of your portfolio with those of other users, you can do that as well by causing the site to generate a scatter graph.
There is also a tool allowing you to view the correlation of two specific investments over a specified time period.
You should definitely spend some time using these asset allocation tools with your own investments. Even if you are using a financial advisor, what you discover may give you some important questions to ask.
What do you think about the value of this asset allocation site to your retirement planning?