Correlation

Correlation measures how closely two assets move together. Essential for genuine diversification. Index Balance calculates it for all funds in your portfolio.

Definition

Correlation between two assets measures how closely their returns move together. It is expressed on a scale from -1 to +1: a correlation of +1 means they always move exactly together, -1 means they always move in opposite directions, and 0 means there is no linear relationship between their movements.

For portfolio diversification, correlation is a crucial metric. Combining assets with low correlation (near 0) or negative correlation reduces the overall portfolio volatility without proportionally reducing expected return. An MSCI World fund and an MSCI Emerging Markets fund have high correlation (~0.80-0.85), meaning they diversify little from each other. High-quality bonds have lower correlation with equities (~0.0 to -0.3), meaning they add more genuine diversification.

Index Balance calculates the correlation between the funds in your portfolio so you can understand how much genuine diversification you are actually achieving.

Practical example

Your portfolio holds an MSCI World fund and an MSCI Europe fund. Their correlation is +0.88: when MSCI World falls 5%, MSCI Europe tends to fall 4.4%. Adding a bond fund with +0.05 correlation to the MSCI World would reduce overall portfolio volatility more than adding another regional equity fund.