The S&P has nearly quadrupled since its 2009 low. It currently ranks as the second-longest bull market in the last 140 years (top green bar).
Just as important as recognizing the frothiness of the current market is the fact that the stock market has always fluctuated between bull and bear markets. No bull market lasts forever—that will include this one.
Regardless of your personal outlook for the stock market, capturing some of your profits is only prudent given how long this market has been chugging higher. It’s also a way to build wealth, since you now have some money to build a position in other investments.
But what? Buying different stocks than what you own would expose you to the same frothy market. The current real estate market wouldn’t allow us to buy low. And loading up on bonds doesn’t really help since they pay next to nothing despite the bump in rates.
There’s actually a straightforward way to achieve true diversification…
The Secret to Effective Diversification
Many investors think they’re diversified because they own domestic stocks and foreign stocks. Or government bonds and corporate bonds. But that’s not real diversification because they’re essentially the same asset class and tend to rise and fall together.
The key to proper portfolio diversification is this:
Buy non-correlated assets
In other words, you want an asset class that tends to rise when others fall. It doesn’t do much good if all your investments rise and fall together.
So what assets might have a low correlation to stocks? In other words, what could you buy that won’t fall victim to the next bear market or recession?
The following 40-year study shows the correlation of gold to other common asset classes. The zero line means gold does the opposite of that investment half of the time. Figures below zero means gold moves in the opposite direction of that investment more often than with it (and vice versa if above zero).
You can see that historically, gold moves opposite of the US stock market more often than with it. They are thus considered negatively correlated assets.
This makes sense when you think about it… stocks benefit from economic growth and stability, while gold responds to economic distress and crisis. If the stock market falls, fear is usually high, and investors typically seek out the safe haven of gold. If stocks are rocking and rolling, the perceived need for gold from investors is low.