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“What information does Portfolio Correlation Pro™ use for its calculations?”
Portfolio Correlation Pro™ dynamically downloads the very latest close-of-market data from Yahoo Finance, ensuring that your calculations are based on the freshest, up-to-date information available. Therefore, you must be connected to the Internet to use the software. By downloading data through Portfolio Correlation Pro™ you agree to be bound by the Yahoo Finance terms of use.
“What type of computer do I need to be able to use Portfolio Correlation Pro™?”
Portfolio Correlation Pro™ is an Excel template that uses Microsoft Office Excel on either a Windows or Mac platform.
“Is Portfolio Correlation Pro™ easy to use?”
We think so. If you can type in the ticker symbols for the securities in your portfolio, and click a button, you can use Portfolio Correlation Pro™. Here are some screen shots from Portfolio Correlation Pro™ so that you can judge for yourself. The first is an annotated example:
Next are the results from Portfolio Correlation Pro™: the numerical data and two charts:
“Where do I get the ticker symbols to type into Portfolio Correlation Pro™?”
There are many websites at which you can find the ticker symbols for thousands of securities traded on dozens of exchanges. Amongst them:
- Yahoo!® Finance (http://finance.yahoo.com/)
- MSN® Money (http://moneycentral.msn.com/home.asp)
- Google™ Finance (http://www.google.com/finance)
- AOL Money and Finance (http://money.aol.com/)
“What, exactly, is correlation? Why is it important?"
Correlation is a statistical measure of how two variables - in this case, the monthly returns on two securities - change relative to each other. Correlations can range from a low of -1.0 to a high of +1.0. A correlation of +1.0 means that the returns of the securities move together: both above their respective averages at the same time, and both below their respective averages at the same time. A correlation of -1.0 means the opposite: when one is above its average, the other is below its average. When the correlation is between these extremes, it means that sometimes they're above average together, sometimes below average together, and sometimes one is above when the other is below.
Correlation is important because it directly contributes to the volatility (riskiness) of your portfolio. If all of the correlations are near +1.0, then every month you'll see either (nearly) all securities with above average returns, or else (nearly) all securities with below average returns; in other words, you'll see very large swings in month-to-month returns in your portfolio. If all of the correlations are near -1.0, you'll see extremely small swings in month-to-month returns in your portfolio.
The more securities in your portfolio, the more important correlation becomes. With two securities, there is only one correlation, so the volatility of the individual securities is likely to be more important than their correlation. With three securities, there are three correlations; with four securities, there are six correlations. The number of correlations grows much faster than the number of securities. With 10 securities, there are 45 correlations, and with 20 securities, there are 190 correlations. You can see that even for a modest number of holdings, the way they work together in the portfolio will easily overwhelm the riskiness of the individual securities. It is quite possible, in fact, to create a very low-risk portfolio containing only high-risk securities, as long as the correlations of returns are very low (preferably, negative).
The graph below illustrates the importance of the correlation of returns for two securities:
Stock A has an annual return of 10% and an annual volatility (standard deviation of monthly returns) of 10%; stock B has an annual return of 20% and an annual volatility of 30%.
The red line, for example, illustrates the risk / return combinations of all portfolios that can be constructed from stocks A and B when their correlation of returns is +1.0; they range from 100% stock A / 0% stock B at the lower left to 0% stock A / 100% stock B at the upper right. The portfolio consisting of 90% A / 10% B will have an annual return of 11% and an annual volatility of 12%, the 50% A / 50% B portfolio will have a return of 15% and a volatility of 20%, the 20% A / 80% B portfolio will have a return of 18% and a volatility of 26%, and so on.
The other curves represent risk / return combinations when the correlations of returns are +0.5, 0.0, -0.5, and -1.0. If the correlation were some other value, the curve would lie between those shown on the graph. For example, the curve showing the risk / return combinations when the correlation is -0.3 would lie between the blue curve (0.0) and the aqua curve (-0.5).
The table below summarizes the effects of correlation of returns:
Correlation | Color | 50% A / 50% B Portfolio | Minimum Risk Portfolio | |||
Return | Risk | Mix | Return | Risk | ||
+1.0 | Red | 15.0% | 20.0% | 100% A | 10.0% | 10.0% |
+0.5 | Yellow | 15.0% | 18.0% | 100% A | 10.0% | 10.0% |
0.0 | Blue | 15.0% | 15.8% | 90% A 10% B | 11.0% | 9.5% |
-0.5 | Aqua | 15.0% | 13.2% | 80% A 20% B | 12.0% | 7.2% |
-1.0 | Green | 15.0% | 10.0% | 75% A 25% B | 12.5% | 0.0% |
Notice that for a 50% A / 50% B portfolio the return remains the same irrespective of the correlation, but the risk decreases as the correlation decreases. Notice, too, that when the correlation is 0.0 or negative, it is possible to get a portfolio with a higher return than stock A and a lower risk than stock A. That's the power of correlation!