Today's Investing Realities Make Cash Even More Important

Of the 11 indexes, the only two showing reduced correlation are the BarCap. U.S. 7-10 Year Treasury Index, going from -0.21 to -0.60, and the BarCap U.S. Aggregate Bond Index, falling from -0.18 to -0.52. Both are bond indexes heavy in investment-grade U.S. bonds, such as Treasuries and corporates.

This negative correlation would, in theory, make investments in those types of bonds a good way to diversify a portfolio that also contains stocks, real estate and commodities. Unfortunately, beefing up on bonds might not be a good way to make money right now, as bond prices could plummet if interest rates were to rise from today’s unusually low levels.

Morningstar says it is unclear exactly why these correlations have increased, but suggests that a key factor may be the fallout from the market crash of 2008. Nervous investors may have developed a “risk-on/risk-off sentiment” that causes them to flood in and out of all types of investments at once, based on whether they see the markets overall as risky or safe.

The rise of new investment products may be another factor. Today it is easy to move money in and out of real estate and commodities with real estate investment trusts and exchange-traded funds. By making these assets more liquid, these vehicles make them more susceptible to investors’ risk-on/risk-off behavior.

As a result of rising correlation, a portfolio that looks widely diversified may not be. Until the trend reverses, there also may not be much to do about it other than keep a large cash reserve as a stabilizing force.

A simple savings or money-market account would do the trick. Yields will be pathetic, but your cash will be federally insured against loss, which could be a life saver if all the other assets in your portfolio head south at the same time.

While a diversified portfolio is always important, there are different investing rules for different times of your life. Check out MainStreet’s Guide to Investing in Your 30s to set up your portfolio the right way!