hi I'm Jimmy in this video we're looking at how we can truly protect our
investment portfolio so I'm sure that everybody's heard Warren Buffett's two
famous rules rule one don't lose money Rule two don't forget
rule one now clearly Buffett's not talking about
a temporary pullback in the stock market he's talking about losing money
permanently but I figure it makes sense to keep our investment portfolios safer
even if the stock market falls and if we could do that well then our investment
portfolio is likely to grow faster and that should help us get her get us
closer to our goal of financial freedom okay so how do we protect our investment
portfolio well one key is to stay diversified but
not all diversification is created the same so what I did is I calculated the
correlation of a bunch of different investments going back the past five
years and to diversify our portfolio more effectively ideally we want
companies or ETFs or sectors or asset classes or whatever it is we want them
to have a lower correlation to our portfolio the lower the correlation the
more effective the diversification is and in theory the safe for our portfolio
becomes okay now just so on the same page I'm gonna walk through a quick
illustration of how correlation can affect a portfolio and I'm gonna use
real numbers from the actual analysis so let's imagine we have our own portfolio
and let's pretend that broadly speaking that portfolio is the S&P 500 maybe we
know in an ETF or whatever it is either way our the S&P 500 is going to
represent our portfolio now the stock market isn't climbing so we've been
pretty happy since our investment portfolios value continues to grow now
at some point the stock market turns lower now imagine we've considered
adding or considered buying some other ETF's to help diversify our way from our
one holding which is the S&P 500 now we're looking at ETF's like IJH which is
the iShares mid cap ETF and then we're also considering AGG which is the
iShares bond etf well over the past five years and by the way I used weekly
numbers to calculate the correlation between all these securities
well the bond etf has a correlation of negative zero point one
when compared to the sp500 meanwhile the mid-cap ETF is showing a positive
correlation of 0.93 so what does this tell us
well correlation runs on a scale from negative 1 all the way over to positive
1 positive 1 indicates a perfect positive correlation which means that
when one investment moves up 5% the other investment will move up 5%
1 1 moves down 10% the other will move down 10% so the theory is that the two
will move exactly like each other when we flip to the other side of the
spectrum negative 1 is a perfect negative correlation and the exact
opposite is true in this situation so when one stock moves up 5% the other one
would move down 5% when one moves up 10 if the other one will move down 10 they
always move opposite of each other finding anything that is perfectly
correlated either negatively or positively can be very tricky if not
impossible to find something for the S&P 500 to be perfectly correlated frankly
you'd have to be looking at another S&P 500 index so using this scale well we
may recall that the bond etf fell right around here which is negative 0.16 and
the mid cap etf came right around here at about 0.93 so if we own the S&P 500
or an ETF that represents the S&P 500 or we can see that adding the mid cap etf
doesn't help diversify us all that much now we can't say that it doesn't help at
all it just doesn't help a lot because 0.93 is quite a high correlation so it
would be like buying two different oil companies sure you help diversify away
from that one company risk but you haven't diversified all that much away
from oil itself now the bond etf on the other hand well this one is actually
quite helpful at diversifying our portfolio we could see that if the S&P 500
were to fall well in theory the bond etf should because it's negatively
correlated in fact to be a bit higher so as the S&P 500 goes down well that one
should go up albeit slightly so that's what we're after we want to find things
with low correlation the correlation doesn't have to be negative to give us
diversification benefits but the the number is compared to our initial
investment the better off we are from a diversification standpoint now take the
utility sector just as another example to represent the utility sector I use
the Vanguard Utilities ETF ticker symbol VPU now when compared to the S&P 500
the utility sector has a correlation of 0.35 which means that yes there is a
positive correlation but the point 3 5 is actually quite low which means that
adding utilities to the sp500 would be a good diversifier when it comes to
protecting our portfolio so this is exactly what we want we're after
protecting our portfolio ideally we want to protect our portfolio from the
what-if scenarios what if the sp500 Falls well bonds and utilities clearly
help that situation now using different sectors is a very good thing and if
we're curious this is a more complete list of some of the sectors that I
pulled down compared to the sp500 over the past five years now we may notice
that the utility sector well that has the lowest correlation in this whole
group that's the reason I use them and the consumer discretionary and
information technology have the highest correlation in fact the industrials are
actually quite high - but either way adding each of those three would add
some diversification benefits but not necessarily as they wouldn't help quite
as much as something like utilities would okay but what about other
investments so here's the S&P 500 compared to a few other investment types
we've got a bond etf that i mentioned before that's AGG we have an emerging
market ETF and then we have another bond etf another emerging markets etf then I
have ETF and I found representing the footsie 100 which gives us access to
London stocks we've got an ETF representing some German stocks and then
we have another one representing some Australian stocks and we can see that
each of these international investments offer a decent amount of diversification
benefits when compared to the S&P 500 so that might be something that we
consider adding to our portfolio depending on what our initial portfolio
looks like now I recognize that this information when presented like this
well it's really only helpful if we want to compare something to the sp500
and like most correlation analysis layouts this is what the more extensive
data looks like for each of the ETF's that I analyzed in this particular
correlation analysis so Tim this one is much more dynamic and allows us to
compare different things compare different sectors to each other and so
on so I put a link in the description below if you want me to send you this
entire spreadsheet now I do think it's important to note that I used weekly
numbers here going back the past five years and since things change all the
time or a correlation analysis would be even different if you looked at one
years or three years or ten years I do think it's important for us to continue
to pay attention and adjusting our investment portfolio to adjust whatever
to whatever risk level were after I'm just giving sort of a baseline of how
this could be done if you'd be curious to see me do any all the types of
analysis like that please let me know in the comments below I'm always interested
this was a very interesting exercise now if you're curious to learn about other
sectors perhaps we're actually doing a series in this on this channel called
dividends from passive income where we're looking for opportunities in each
of the eleven geek sectors and if you're curious that could be a good next series
for you to watch there's a link right here and there's a link in the
description below and thank you so much for stick with me all the way into the
video I really appreciate it I hope you found this interesting thanks and I'll
see you in the next video