What is Correlation? Does it Matter to Me?
Correlation. What is it? and why does it matter?
Correlation is the relationship between two things. In the investment world it the relationship between 2 different investments. If one goes up 8% and the other goes up 8% then they are perfectly correlated. If one goes up 8% and the other goes down 8% then they are negatively correlated. Then of course there is everything in between. When building a portfolio, one of the measures that we use is correlation. The purpose of diversification is to have assets that are not perfectly correlated. Assets can also be “uncorrelated” which can be a good thing! Then again, it’s hard when one asset is doing well to not want all of them to be doing that well. However, that defeats the purpose of diversification and the need for non-correlated or low-correlated assets.
Check out this short write up to get some more details!