Silver Lining
Correlation is a statistical measurement of how closely two investments move together and is a key element in creating diversified portfolios. So far in 2022, diversification hasn’t helped much.
Two vey broad asset classes we use in portfolios are stocks and bonds. Typically, these two asset classes have a very low correlation, or even a negative correlation. What this means is that when one goes up, the other often goes down. This is helpful because combining these two asset classes has an offsetting effect and acts as a hedge for a portfolio by decreasing volatility.
This year, stocks and bonds have been highly correlated, and diversification has done little to decrease portfolio volatility. The SP500 is down 14% year to date and the Barclays Aggregate Bond Index is down 11%. Those who feel this volatility the most are more conservative investors who aren’t used to such large swings in the value of more conservative assets.
From 1950 to 2021, stocks have had an average return of 11.5% and a calendar year range of -39% to +47%. The 16% correction we are seeing in the SP500 is well within that range. Bonds, however, have an average return of 5.8% with a calendar year range of -8% to +43%. The 11% loss so far this year exceeds the 71 year range of the asset class and stands out as a true anomaly in the history of bond investing.
There is, however, a silver lining. The decrease in the price of bonds is not from an economic disaster or mass bankruptcies, it is from rising interest rates. As you can purchase new bonds with higher interest rates, old bonds with lower rates are, for a time, less valuable. These bonds will typically mature at face value and in a portfolio that holds a number of bonds, when they mature, new, higher yielding bonds are purchased. This can increases the yield of a portfolio and lead to higher long term rates of return. Rising interest rates often creates short term pain but long term gain for investors.
What to do? First, the best performing asset class so far this year has been cash. Using a sell high and buy low philosophy, it might be the right time for putting excess cash to work. Additionally, as we move towards peak interest rates, we can shift from short term to long term bond exposure to lock in higher interest rates – we aren’t there yet, but the time may be coming soon. Finally, for those looking to add risk to their portfolio or make tactical purchases, keeping an eye on the tech heavy NASDAQ would make sense as it has fallen significantly form its 2021 highs.
The information given herein is taken from source that IFP Advisors, LLC, dba Independent Financial Partners (IFP), IFP Securities, LLC, dba Independent Financial Partners (IFP), and its advisors believe to be reliable, but is not guaranteed by us as to accuracy or completeness. This is for information purposes only and in no event should be construed as an offer to sell or solicitation or an offer to buy any securities or products. Please consult your tax and/or legal advisor before implementing any tax and/or legal related strategies mentioned in this publication as IFP does not provide tax and/or legal advice. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation, or needs of individual investors. This report may not be reproduced, distributed, or published by any person for any purpose without IFP's express prior written consent.