3 Assets That May Not Diversify as Well as You Think

Ladies and gentlemen, listen up! Today, we're diving into the world of diversification, and I'm here to tell you that not all assets are created equal. You might think you're spreading your risk, but some of these so-called diversifiers could be setting you up for a fall. Let's get into it!



Real Estate: The Great Diversifier Myth

For years, real estate investment trusts (REITs) have been touted as the ultimate diversifier. But let me tell you, the game has changed! In the early 2000s, REITs were untethered from the broader equity market, with correlations as low as 0.10. That's what you call a true diversifier! But fast forward to today, and the story is different. For the trailing three-year period ended April 30, 2024, the FTSE Nareit All Equity REITs Index had a correlation of 0.88 with the broader equity market. That's right, folks, real estate has been moving in line with stocks, making it a less valuable cushion against bear-market declines.

So, what's the takeaway? Don't count on real estate to save your portfolio during the next market downturn. You need to be smarter than that!

High-Yield Bonds: The Junk Bond Joke

Next up, we have high-yield bonds, also known as junk bonds. These bonds are issued by corporations with below-average credit ratings, and they've been marketed as a way to diversify your bond portfolio. But here's the kicker: high-yield bonds have a relatively high correlation with stocks. They typically suffer during periods of weaker economic growth, which are also negative for stocks. For the most recent three-year period through April 30, 2024, high-yield bonds had a correlation of 0.88 when measured against stocks. That's not diversification, folks; that's a recipe for disaster!

So, what should you do? Stay away from high-yield bonds if you're looking for true diversification. Instead, consider investment-grade bonds or even Treasuries, which have done a much better job of cushioning downside risk.

Cryptocurrency: The Volatility Vampire

Last but not least, we have cryptocurrency. This digital asset has had an extremely low correlation with most other major asset classes, making it seem like the perfect diversifier. But here's the catch: as digital assets have attracted more interest from mainstream investors, correlations have steadily trended up in recent years. For the trailing three-year period ended in 2023, the MarketVector Bitcoin Index had a correlation coefficient of 0.55 with stocks. That's not the noncorrelated asset you were hoping for!

And let's not forget about the extreme volatility. Over the past three years, bitcoin has been nearly 4 times as volatile as stocks. Much of this volatility has been on the upside, but bitcoin and other cryptocurrencies have also been subject to extreme drawdown risk. So, while crypto might seem like a great diversifier on paper, the reality is much different.

So, what's the bottom line? Don't let the hype fool you. Cryptocurrency is a high-risk, high-reward game, and it's not the diversifier you think it is.

The Takeaway

Ladies and gentlemen, diversification is a core principle of sound investing, but not all assets are created equal. Real estate, high-yield bonds, and cryptocurrency may not provide the diversification benefits you think they do. So, do your homework, stay informed, and make smart investment decisions. Your portfolio will thank you!