Which was the best investment in the past 30, 50, 80, or 100 years? This chart compares the performance of the S&P 500, the Dow Jones, Gold, and Silver. The Dow Jones is a stock index that includes 30 large publicly traded companies based in the United States. It is one of the oldest and most-watched indices in the world. The S&P 500 consists of 500 large US companies, it is capitalization-weighted, and it captures approximately 80% of available market capitalization. For these reasons it is more representative of the US stock market than the Dow Jones. Both versions of these indices are price return indices in contrast to total return indices. Therefore, they do not include dividends. Including dividends leads to a very different picture, which is demonstrated in the chart below.
In contrast to the S&P 500 Price Index and the Dow Jones, the Wilshire Large-Cap is a total return index, in which all resulting cash payouts (including dividends) are automatically reinvested back into the fund itself. Therefore, it includes all capital gains and it allows for an accurate performance comparison with Gold and Silver.
Unfortunately, the Wilshire Large-Cap only dates back to 1978. For this reason the S&P 500 Total Return from 1871 until 1977 was calculated based on Robert Shiller's data and added to the Wilshire index. Both indices are very similar. While the S&P 500 includes 500 companies, the Wilshire Large-Cap includes 750 companies. Both indices are capitalization-weighted and both are considered benchmarks for large-cap stocks.
The chart above displays the 1-year rolling correlation coefficient between the S&P 500 and the price of Gold. A correlation coefficient of +1 indicates a perfect positive correlation, meaning that the S&P 500 and gold moved in the same direction during the specified time window. Conversely, a correlation coefficient of -1 indicates that the S&P 500 and gold moved in opposite directions. The chart shows that the correlation between the S&P 500 and gold is not stable and can vary, even during economic recessions. There are periods during which the price on gold did not change, which results in a standard deviation of zero and a correlation plus or minus infinity. These periods are removed from the data set and appear as gaps in the rolling correlation series. The correlation coefficient is important for diversification because it helps investors assess the potential benefits of including both equities and gold in their investment portfolios.
Diversification is the practice of spreading investments across different asset classes to reduce risk. In his book Principles, Ray Dalio called diversification the “Holy Grail of Investing”. He realized that with fifteen to twenty uncorrelated return streams, he could dramatically reduce the risks without reducing the expected returns.
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