Portfolio
Correlation
Correlation ranges from minus one to plus one. A correlation of plus one means two assets move in lockstep, minus one means they move in opposite directions, and zero means their movements are unrelated.
The concept is central to diversification. Combining assets with low or negative correlation smooths a portfolio's returns, because losses in one holding can be offset by gains or stability in another.
A hazard is that correlations are not fixed. In a crisis, assets that normally move independently can all fall together as investors sell everything, undermining diversification just when it is needed most.
Example
Stocks and government bonds have often had a low or negative correlation, which is why holding both can steady a portfolio.
Correlation — FAQ
What is Correlation?
Correlation measures how closely two assets move in relation to each other, on a scale from perfectly opposite to perfectly aligned.
Can you give an example of Correlation?
Stocks and government bonds have often had a low or negative correlation, which is why holding both can steady a portfolio.
Understanding creates conviction.
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