For instance, correlations between large-cap stocks and small-cap stocks are fairly high, but there's almost no correlation between stocks and gold prices. They won't all have negative price correlations, like stocks and Treasury bills, but some will and others may have no correlation at all. To truly diversify, you want to invest across asset classes with a low correlation to one another. So, while stocks are more volatile than bonds, adding some stocks to a bond portfolio will make the overall volatility decrease because the two assets generally move in opposite directions. That negative correlation implies that when the stock fund increases in value, the Treasury bond fund decreases in value, and vice versa. The prices of the stock and bond ETFs above have a correlation around -0.32. The factor that makes it possible to decrease the volatility of your portfolio while increasing returns is the price correlation between asset classes. The latter portfolio also historically returns over 4% more per year on average. But if you move vertically on that chart to the point above it on the efficient frontier, you can find a portfolio with the same risk profile, but greater expected return - about 88% stocks and 12% bonds. The bottom of the chart shows the risk return profile of investing 100% in the iShares bond ETF. The left edge of the chart shows the asset allocation that minimizes risk - at about 44% stocks and 56% bonds. It depicts the best possible return for any given level of variance in portfolio returns. The efficient frontier is part of Harry Markowitz's Modern Portfolio Theory, which won him a Nobel Prize in economics. What's more, you'll be able to see greater returns for the same level of risk with proper diversification across the two assets. stock market index fund like the Vanguard Total Stock Market Index Fund ETF ( NYSEMKT:VTI). government defaults on its debt, you probably have bigger things to worry about than going broke.ДЄctually, investing all your money in treasury bonds carries more risks than splitting it up between Treasury bonds and a U.S. treasury bonds is the best way to do that. You might think investing all of your money in U.S. Let's say you wanted to get a relatively safe return on your investment, but still get your money working for you. How to get greater returns without increasing risk But if you want to understand diversification and why a 60/40 stock-to-bond ratio might make sense, be sure to check out the chart below. Many investors stick with basic portfolio allocations like 60% stocks, 40% bonds because someone told them that's a good balance. If you diversify across asset classes properly, you can maximize your returns for your risk tolerance. Follow investors know diversification is an essential piece of planning their portfolio. For some lighthearted stock commentary and occasional St. He spends about as much time thinking about Facebook and Twitter's businesses as he does using their products. He consumes copious cups of coffee, and he loves alliteration. Adam has been writing for The Motley Fool since 2012 covering consumer goods and technology companies.

Efficient frontier chart