Correlation

A measure from +1 to -1 of how closely two assets have moved together over a chosen period. +1 is lockstep, 0 is no relationship, -1 is exactly opposite.

Example

Two assets each with 20% volatility, held equally, produce a portfolio volatility of 20.0% at a correlation of +1, 14.1% at 0, and 10.0% at -0.5.

Important

A correlation is a measurement of a past window, not a property of the assets. Different windows give materially different answers for the same pair.

Related terms

• Correlation breakdown — The tendency for historical relationships between assets to stop holding under stress, as correlations between risky assets converge towards one in a severe decline.
• Diversification — Holding enough genuinely different assets that no single outcome decides your result. It reduces risk specific to individual holdings; it does not reduce the risk they all share.
• Standard deviation — A statistical measure of how spread out an asset's returns are around their average - the common numeric stand-in for volatility.

Lessons that explain it

• For most alternatives, the entire return is one number: the exit price minus everything paid to get there — Without a dividend or a coupon, appreciation is the whole story for art, wine and watches - and it only becomes real at an actual sale. Farmland and royalty interests instead compound the way an income-producing asset does, cash paid out year after year. (11 min)
• This belongs in the money you could genuinely lose, sized small, and held for reasons beyond the return — The apparent low correlation with financial markets is partly real and partly an artefact of how these assets are valued - and once round-trip costs and total-loss risk are honestly priced in, this asset class fits only as a small, patient allocation of money whose absence would not change anyone's plans. (10 min)
• The job bonds do: a date, a sum, and a different response to the same shock — Only fixed income lets you name the amount and the day in advance. The diversification argument is the one usually made for it, and it is the one that has failed. (8 min)
• Sometimes the only thing that rose, sometimes the thing that fell furthest — It genuinely protects a portfolio in some shocks and genuinely makes them worse in others, and the average of those two behaviours describes neither. That is the honest case, and it is a case for a small deliberate position. (10 min)
• A sized bet, renewed on purpose — If it belongs anywhere, it belongs as a position small enough that a total loss is survivable - and the diversification argument most often used to justify it has a habit of failing in exactly the weeks it is needed. (9 min)
• Correlation: what actually moves together — Diversification is only worth what the independence behind it is worth, and correlation is how that independence is measured - including the fact that it changes exactly when you need it not to. (12 min)

All 578 terms in the Investing glossary