Yesterday afternoon I found myself in a windowless cell deep in the bowels of MoneyWeek HQ, getting shouted at by an Australian.
I’d been invited around to appear on MoneyWeek’s new podcast, Capital & Crisis, with Dan Denning and Nick O’Connor. (And to be fair, Dan’s much too polite to shout. It was a spirited but respectful debate.)
The Capital & Crisis crew took issue my recent Penny Sleuth articles about the role of central banks in the economy. They don’t see things like I do… so we argued about it!
You can listen to the podcast on the Apple podcast store, or at moneyweek.com.
Our disagreement boiled down to this: when it comes to central banks and money printing, I think there’s such a thing as a free lunch. Dan and Nick do not.
To be fair, there was much we did agree about. One thing was about the beauty of “uncorrelated returns”. And that term might sound boring, but it’s the biggest “free lunch” in all of investing.
Here’s what it means.
Returns or safety: choose one
Correlation describes the relationship between two different variables. If two assets are “highly correlated”, they both tend to move in the same way. The Dow Jones index and the S&P 500 index are highly correlated. If two assets are “negatively correlated”, they tend to go in opposite directions. Examples of negatively correlated assets include the gold price and inflation-adjusted interest rates. If two assets are uncorrelated, there is no relationship between them one way or the other. It’s uncorrelated assets I want to write about today.
So why would you actually want uncorrelated assets?
Well, when it comes to investing in financial assets there’re basically two things to think about.
Will it go up in value?
Will I be able to turn it into cash when I need it?
As I’ve written before, these two ideas are linked. Assets which go up in value a lot tend to be very volatile (which means it’s hard to turn it into cash when you need it).
If you know you’re going to need your money for retirement in a year’s time, it doesn’t make sense to put it in assets that are volatile. Even if they do go up a lot in value!
And if you’re investing for the long run, and won’t need to turn your investments into cash any time soon, then it makes sense to invest in the assets that will go up most in value.
So that’s the trade-off. Stuff that goes up a lot in value, versus stuff whose value can be hard to realise when you need it.
But what if you could have your cake and eat it too? If you could invest in the type of assets that go up most quickly, without having to worry that they won’t be around at the moment when you want to turn them into cash?
THAT’s what you want uncorrelated assets for!
If your portfolio has assets which aren’t correlated to each other – in other words, whose value moves independently of each other – you lessen the overall volatility of your portfolio. That makes it easier to turn it into cash when you need it. Stuffing your portfolio with assets that aren’t correlated to each other means you can get more returns, for the same risk.
And would you believe it, but my penny share stock picking strategy gives you exactly that. It gives you exciting small companies with the potential for big returns. And the returns aren’t correlated with the overall market.
It’s the biggest free lunch in investing!