Correlation

Correlation measures how two assets move together, from −1 (opposite) to +1 (lockstep).

A quick example

How to apply it

Choose assets for their expected correlation, not just their individual returns. A mix of stocks, bonds, and alternatives with low mutual correlation is what actually cushions crashes — and accept that in extreme stress, correlations converge.

What it means for you

It is the maths behind real diversification — low or negative is the goal.

Picture this

A portfolio pairs U.S. stocks with an international stock fund, believing two markets diversify each other. In normal years the correlation between them is modest and the pairing smooths returns. In a global selloff, however, investors dump everything at once, the correlation jumps toward 1, and both funds fall together — the diversification vanishes exactly when needed. The scenario is why pairing two similar asset classes is weaker diversification than pairing genuinely different ones, like stocks with bonds.

Common mix-ups

Correlations rise in crises when you most want them low, a known trap.

Key takeaway

Correlation is the maths behind diversification: assets that move together add no safety, while low or negative correlation smooths the ride. The catch is that correlations are unstable and spike toward 1 in crises, exactly when you need diversification most. Choose assets for their expected co-movement, not just their individual returns, and pair genuinely different classes — stocks with bonds, not two stock-like funds. The portfolio is smoother than its parts only when the parts do not march together.

Definitions reviewed by the Investing Glossary editorial team.