The Cross-over

Abstract

Imagine you had a choice between only two investments: stocks and bonds. Which would you choose? Investors in bonds are conservative, seek stable income and have a longer-term investment horizon. Investors who purchase stocks are “aggressive” and want high returns in a shorter period of time. The distinction between stocks and bonds has been in place since the 1920s, when investing became popular. The distinction has been quantified by a correlation that has been mostly negative between the price of bonds and the price of stocks. Investors who seek diversification would therefore have a portfolio of bonds and stocks, for example, weighted by 40 percent in bonds and 60 percent in stocks. The question of which of the two investments would be the top choice is answered by the weights of each in the portfolio. The answer should also focus on the cross-over return between the two asset classes. The cross-over return is defined as the return on bonds that is influenced by the return on stocks and vice versa. Investors may not understand how much, in certain periods, the returns of bonds can be closely correlated with stock returns.