Correlation
Also: correlation, correlation coefficient, return correlation
A statistical measure of how two investments move together, ranging from -1.0 (perfect opposite) to +1.0 (perfect co-movement). Low correlation between portfolio assets reduces overall volatility.
Correlation measures the degree to which two securities or asset classes move together. A correlation of +1.0 means they move in lockstep; 0.0 means they are independent; -1.0 means they move inversely. Portfolio theory holds that adding assets with low correlation to each other reduces portfolio variance at any given return level. US stocks and US bonds have historically shown correlation near zero over long periods, though correlations typically rise in short-term crises.
Example: a tech employee’s employer stock and the Nasdaq 100 have a 0.82 correlation. Buying QQQ as a “diversifier” adds little protection: when the employer falls, QQQ usually falls too. Adding international bonds at correlation 0.1 to employer stock provides real diversification.
Common mistake: assuming “diversified” means “uncorrelated.” Holding five large-cap tech stocks gives the illusion of diversification but produces correlations of 0.7 to 0.9 in downturns.
Correlation matters at concentrated stock hedging (pick uncorrelated assets), at international allocation sizing, and at portfolio stress testing where correlations shift upward in crises.