Glossary · Risk · Beginner-friendly
Correlation
In plain English
Correlation asks: do two investments usually move together? If they always rise and fall as a pair, they don’t protect each other much.
Everyday analogy: Two friends who always show up to the same parties - when one is absent, so is the other.
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Why it matters
Correlation tells you whether two holdings actually diversify each other - and it can change in stress.
A bit more detail (optional)
Reading the number
Correlation near +1 means they move together; near −1 means they often move opposite; near 0 means little linear relationship.
Unstable in stress
Historical correlations can break in crashes. Treat them as guides, not guarantees.
Simple examples
Stock/bond mix
Stocks and bonds often diversify each other - until inflation shocks hit both at once.
Inflation shock
Stocks and long bonds both fall when inflation surprises hotter - the classic diversifier temporarily fails.
Easy mistakes to avoid
- Treating a 5-year correlation as permanent
- Adding “diversifiers” that all rise and fall with risk appetite
- Ignoring that crisis correlations often spike toward 1
Remember: Diversification only works when correlations cooperate - watch regime shifts.