Building a portfolio
Covariance
How two investments move together, measured in units that also reflect how much each one moves.
How it works
Covariance is the raw ingredient; correlation is covariance standardised so it always falls between −1 and +1. Portfolio risk maths is built on covariance because the size of the moves matters, not only their direction.
Formula
Correlation = covariance(A, B) ÷ (standard deviation of A × standard deviation of B)Related terms
- CorrelationA measure from −1 to +1 of how closely two investments move together.
- VolatilityHow much an investment’s returns bounce around their average — the standard measure of risk.
- Modern portfolio theoryThe framework that treats risk as portfolio-level volatility and finds the best return for a given level of it.
More in Building a portfolio
- Drift
- Effective number of holdings
- Core and satellite
- Efficient frontier
- Concentration risk
- Fund overlap
- Asset allocation
- Glide path
All 20 Building a portfolio terms · The full glossary, 433 terms
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