Understanding Correlation Coefficients

Correlation ranges from +1 (move together) to -1 (move in opposite directions) A correlation of zero means the two assets move independently of each other US stocks and long-term bonds have historically shown low or negative correlation Correlations are not fixed — they shift over time as economic conditions change

Modern Portfolio Theory Basics

Harry Markowitz showed that portfolio risk depends on correlations, not just individual volatilities The efficient frontier maps the highest return achievable at each level of risk Adding low-correlation assets shifts the frontier upward and to the left MPT assumes stable correlations and normal distributions, both of which break down in practice

Correlation Breakdown During Crises

Correlations between risky assets tend to spike during market panics and recessions In 2008, most asset classes sold off together as investors fled to cash and Treasuries The diversification benefit you need most often disappears at the worst possible time Tail-risk hedging and truly uncorrelated assets matter more during stress events

Asset Classes and Their Typical Correlations

US and international developed stocks show high correlation, around 0.8 or above Bonds and equities have averaged low correlation but turned positive in 2022 Real assets like commodities and real estate often provide meaningful diversification Alternatives such as managed futures have shown near-zero long-term equity correlation

Building a Genuinely Diversified Portfolio

Focus on the underlying economic drivers of returns, not just asset class labels Include assets that respond differently to growth, inflation, and interest rate changes Holding stocks across sectors and geographies improves diversification within equities Avoid over-diversifying into assets so correlated they add complexity without benefit

Measuring, Monitoring, and Implementing

Use rolling 36-month windows to track shifting correlation relationships Stress test with historical crisis scenarios to reveal hidden concentration A mix of US stocks, international stocks, bonds, TIPS, and alternatives is a solid start Rebalance periodically to maintain target allocations as correlations and returns shift

Correlation and Portfolio Diversification: Building Resilient Portfolios

Curated by: Rubric Advisors

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Why Diversification Actually Works

Combining assets that do not move in lockstep reduces overall portfolio volatility
Diversification lowers risk without necessarily sacrificing expected return
A portfolio of 30 unrelated stocks eliminates most company-specific risk but not market risk
The benefit comes from holding assets whose returns offset each other in different conditions

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Why Diversification Actually Works

Understanding Correlation Coefficients

Modern Portfolio Theory Basics

Correlation Breakdown During Crises

Asset Classes and Their Typical Correlations

Building a Genuinely Diversified Portfolio

Measuring, Monitoring, and Implementing

Related Topics

Asset Allocation Principles

Building a Portfolio with ETFs

Exchange Funds

Why Diversification Actually Works

Understanding Correlation Coefficients

Modern Portfolio Theory Basics

Correlation Breakdown During Crises

Asset Classes and Their Typical Correlations

Building a Genuinely Diversified Portfolio

Measuring, Monitoring, and Implementing

Related Topics

Asset Allocation Principles

Building a Portfolio with ETFs

Exchange Funds