Investing to Wealth

The concept of diversification is tightly coupled with the notion of correlation between securities that make up portfolio. The correlation coefficient is a statistical measurement between negative one and positive one that measures the degree to which the various assets in a portfolio can be expected to perform in a similar fashion or not. A measure of -1 means that the assets within the portfolio perform perfectly oppositely: whenever one asset goes up, the other goes down. A measure of 0 means that the assets fluctuate independently, i.e. that the performance of one asset cannot be used to predict the performance of the others. A measure of 1, on the other hand, means that whenever one asset goes up, so do the others in the portfolio. To eliminate diversifiable risk completely, one needs an intra-portfolio correlation of -1, although in reality, perfectly correlated securities are very rare.