{"concept":{"id":83,"slug":"correlation","term":"Correlation","shortDefinition":"The tendency of two assets to move in the same direction, in opposite directions, or independently in response to the same events -- the real mechanism through which diversifying reduces a portfolio's risk.","longDefinition":"Correlation measures the tendency of two assets to move in the same direction, in opposite directions, or independently in response to the same events. Two highly correlated assets tend to rise and fall together; two assets with low or negative correlation don't move similarly, or even move in opposite directions. It's the real mechanism behind the benefit of diversifying, already covered in general terms in Module 2: combining assets with low correlation to each other reduces the portfolio's overall risk more than combining highly correlated assets would. It shouldn't be confused with volatility, already covered in Level 1: volatility measures how much a single asset moves on its own, while correlation measures how two assets move relative to each other -- an asset can be very volatile and, at the same time, have low correlation with another."},"relations":{"requirement":[],"contrast":[],"related":[{"concept":{"id":81,"slug":"diversification","term":"Diversification","shortDefinition":"Combining assets in a portfolio that don't all behave the same way in response to the same events, to reduce risk without proportionally reducing expected return -- it reduces risk, it doesn't eliminate it.","longDefinition":"Diversification is the practice of combining assets in a portfolio that don't all behave the same way in response to the same events -- when some fall, others don't fall to the same degree, or even rise -- which reduces the portfolio's overall risk without proportionally reducing its expected return. It operates within the asset allocation already decided, covered in Module 1: it spreads the capital assigned to each asset class across several specific assets, instead of concentrating it in just one. It can be applied across different dimensions -- for example, geographically and by sector -- all of them forms of the same idea. Diversification reduces risk, but doesn't eliminate it: part of the risk affects the market as a whole, and no allocation of capital within that market eliminates it completely."}},{"concept":{"id":84,"slug":"position-sizing","term":"Position sizing","shortDefinition":"The criterion for deciding how much weight a position should have in a portfolio based on how much concentration risk it introduces and how correlated it is with the rest -- a tool for controlling its contribution to risk, not a universal formula.","longDefinition":"Position sizing is the criterion for deciding how much weight a specific position should have within a portfolio, inside the asset allocation already decided in Module 1. It rests on two factors: the concentration risk a position introduces -- the greater its weight, the greater the part of the portfolio exposed to whatever happens specifically to that position -- and its correlation with the rest of the portfolio -- a position highly correlated with the others contributes more to overall risk than one with low correlation, even with the same nominal weight. It's a tool for controlling how much a specific position contributes to a portfolio's risk, not a universal formula or a fixed percentage that automatically determines how much anyone should invest in any position."}}],"calculatedBy":[]},"curricularPosition":[{"id":75,"moduleId":27,"slug":"what-is-correlation-between-assets","title":"What is correlation between assets?","summary":"You understand what correlation between assets is and why it's the real mechanism through which diversifying reduces risk.","bodyMarkdown":"## Objectives\n\nBy the end of this lesson you understand what correlation between assets is and why it's the real mechanism through which diversifying reduces risk.\n\n## Content\n\nThe previous lesson introduced concentration risk -- the problem diversifying solves. This lesson names the mechanism that makes diversifying work: correlation between assets, something Module 2 described only in qualitative terms, without naming it.\n\nCorrelation measures the tendency of two assets to move in the same direction, in opposite directions, or independently, in response to the same events. Two highly correlated assets tend to rise and fall together: what affects one tends to affect the other similarly. Two assets with low, or even negative, correlation don't move similarly -- they can react differently, or even in opposite directions, to the same event.\n\nThis is precisely what makes diversifying work: combining assets with low correlation to each other reduces the portfolio's overall risk more than combining highly correlated assets would, even if both combinations spread the same capital across the same number of positions. Two companies in the same sector tend to have higher correlation with each other than two companies in unrelated sectors, because they share more factors that affect them similarly -- the same idea as sector diversification, already covered in Module 2, now explained from its underlying mechanism.\n\nIt's important not to confuse correlation with volatility, already covered in Level 1: volatility measures how much a single asset moves on its own, while correlation measures how two assets move relative to each other. They're distinct properties -- an asset can be very volatile and, at the same time, have low correlation with another asset in the portfolio, and a low-volatility asset can still be highly correlated with another.\n\n## Example\n\nTwo companies in the same tech sector tend to rise and fall together in response to news affecting that sector -- they have high correlation. A tech company and a company in an unrelated sector -- food, for example -- don't usually react the same way to that same news: their correlation is lower, and combining them reduces the portfolio's overall risk more than combining two similar tech companies would.\n\n## Common mistakes\n\n- Thinking combining many assets is enough for good diversification, without considering whether they're correlated with each other.\n- Confusing correlation with volatility -- a low-volatility asset can still be highly correlated with another, and a highly volatile asset can have low correlation with the rest of the portfolio.\n\n## Summary\n\nCorrelation measures how two assets move relative to each other in response to the same events -- the real mechanism through which combining low-correlation assets reduces a portfolio's risk more than combining highly correlated ones. It shouldn't be confused with volatility, which measures how much a single asset moves on its own.\n\n## Self-check\n\nWhy does combining low-correlation assets reduce a portfolio's risk more than combining highly correlated assets?\n\nWhy are correlation and volatility distinct properties of an asset?","bodyHtml":"<h2>Objectives</h2>\n<p>By the end of this lesson you understand what correlation between assets is and why it's the real mechanism through which diversifying reduces risk.</p>\n<h2>Content</h2>\n<p>The previous lesson introduced concentration risk -- the problem diversifying solves. This lesson names the mechanism that makes diversifying work: correlation between assets, something Module 2 described only in qualitative terms, without naming it.</p>\n<p>Correlation measures the tendency of two assets to move in the same direction, in opposite directions, or independently, in response to the same events. Two highly correlated assets tend to rise and fall together: what affects one tends to affect the other similarly. Two assets with low, or even negative, correlation don't move similarly -- they can react differently, or even in opposite directions, to the same event.</p>\n<p>This is precisely what makes diversifying work: combining assets with low correlation to each other reduces the portfolio's overall risk more than combining highly correlated assets would, even if both combinations spread the same capital across the same number of positions. Two companies in the same sector tend to have higher correlation with each other than two companies in unrelated sectors, because they share more factors that affect them similarly -- the same idea as sector diversification, already covered in Module 2, now explained from its underlying mechanism.</p>\n<p>It's important not to confuse correlation with volatility, already covered in Level 1: volatility measures how much a single asset moves on its own, while correlation measures how two assets move relative to each other. They're distinct properties -- an asset can be very volatile and, at the same time, have low correlation with another asset in the portfolio, and a low-volatility asset can still be highly correlated with another.</p>\n<h2>Example</h2>\n<p>Two companies in the same tech sector tend to rise and fall together in response to news affecting that sector -- they have high correlation. A tech company and a company in an unrelated sector -- food, for example -- don't usually react the same way to that same news: their correlation is lower, and combining them reduces the portfolio's overall risk more than combining two similar tech companies would.</p>\n<h2>Common mistakes</h2>\n<ul><li>Thinking combining many assets is enough for good diversification, without considering whether they're correlated with each other.</li><li>Confusing correlation with volatility -- a low-volatility asset can still be highly correlated with another, and a highly volatile asset can have low correlation with the rest of the portfolio.</li></ul>\n<h2>Summary</h2>\n<p>Correlation measures how two assets move relative to each other in response to the same events -- the real mechanism through which combining low-correlation assets reduces a portfolio's risk more than combining highly correlated ones. It shouldn't be confused with volatility, which measures how much a single asset moves on its own.</p>\n<h2>Self-check</h2>\n<p>Why does combining low-correlation assets reduce a portfolio's risk more than combining highly correlated assets?</p>\n<p>Why are correlation and volatility distinct properties of an asset?</p>","sortOrder":2,"readingMinutes":7,"difficulty":"Intermedio","url":"/en/academy/portfolio-management/risk-management/what-is-correlation-between-assets"},{"id":83,"moduleId":30,"slug":"how-do-you-build-an-investment-portfolio-step-by-step","title":"How do you build an investment portfolio, step by step?","summary":"You know how to combine the asset allocation, diversification, and risk management already covered in this level to build a real investment portfolio, step by step.","bodyMarkdown":"## Objectives\n\nBy the end of this lesson you know how to combine the asset allocation, diversification, and risk management already covered in this level to build a real investment portfolio, step by step.\n\n## Content\n\nThis level's five previous modules introduced, one by one, the criteria that make up a coherent portfolio: asset allocation based on risk profile and time horizon, diversification, managing concentration risk and correlation, rebalancing, and investor taxation. This lesson doesn't add any new criterion -- it brings together the ones already covered into a practical sequence.\n\nThe starting point is always the same: asset allocation, already covered in Module 1, decided from the investor's risk profile and time horizon. That allocation sets, in general terms, what proportion of the portfolio would correspond to each asset class -- stocks, bonds, ETFs, investment funds, commodities, or currencies, all already covered in Level 1 -- before choosing any specific instrument.\n\nOnce the allocation is set, the next step is diversifying within each asset class and across them, already covered in Module 2: combining assets that don't all behave the same way reduces the portfolio's risk without proportionally reducing expected return. Diversifying isn't simply adding up different instruments -- it's watching, as Module 3 showed, that no position concentrates a disproportionate risk, taking into account how the chosen positions relate to each other.\n\nSizing each position, also covered in Module 3, is what translates the allocation and diversification into concrete numbers: how much weight each position gets within the portfolio, consistent with its contribution to overall risk, not just with the investor's conviction in that specific idea.\n\nFinally, building a portfolio doesn't end at the moment of purchase. The tax cost of trades -- already covered in Module 5 -- and the future need to rebalance -- already covered in Module 4 -- are part of the criteria from the start, not an afterthought: a well-built portfolio anticipates that it will need to be reviewed over time, a topic the next lesson develops.\n\n## Example\n\nAn investor with a long time horizon and a risk profile that tolerates swings decides, based on their asset allocation, to put most of the portfolio into stocks and a smaller part into bonds. Within the stock portion, they diversify across several companies and sectors instead of concentrating the investment in just one; within the bond portion, they do the same across several issuers. Position weights have been set accounting for their contribution to concentration risk and how they relate to the rest of the positions.\n\n## Common mistakes\n\n- Choosing the specific instruments first and deciding the asset allocation afterward, instead of the other way around -- the allocation should precede the selection, not follow it.\n- Confusing \"diversifying\" with \"accumulating many different instruments\" without watching the real correlation between them.\n- Building the portfolio without considering from the start that it will have a tax cost and will need rebalancing -- treating both as a later surprise instead of a design criterion.\n\n## Summary\n\nBuilding a real portfolio means applying, in sequence, the criteria already covered in this level: asset allocation based on risk profile and time horizon, diversification within and across asset classes, sizing each position based on its contribution to overall risk, and anticipating the tax cost and the future need to rebalance.\n\n## Self-check\n\nWhy should asset allocation be decided before choosing the specific instruments that will make up the portfolio?\n\nWhy isn't diversifying the same as simply accumulating different instruments?","bodyHtml":"<h2>Objectives</h2>\n<p>By the end of this lesson you know how to combine the asset allocation, diversification, and risk management already covered in this level to build a real investment portfolio, step by step.</p>\n<h2>Content</h2>\n<p>This level's five previous modules introduced, one by one, the criteria that make up a coherent portfolio: asset allocation based on risk profile and time horizon, diversification, managing concentration risk and correlation, rebalancing, and investor taxation. This lesson doesn't add any new criterion -- it brings together the ones already covered into a practical sequence.</p>\n<p>The starting point is always the same: asset allocation, already covered in Module 1, decided from the investor's risk profile and time horizon. That allocation sets, in general terms, what proportion of the portfolio would correspond to each asset class -- stocks, bonds, ETFs, investment funds, commodities, or currencies, all already covered in Level 1 -- before choosing any specific instrument.</p>\n<p>Once the allocation is set, the next step is diversifying within each asset class and across them, already covered in Module 2: combining assets that don't all behave the same way reduces the portfolio's risk without proportionally reducing expected return. Diversifying isn't simply adding up different instruments -- it's watching, as Module 3 showed, that no position concentrates a disproportionate risk, taking into account how the chosen positions relate to each other.</p>\n<p>Sizing each position, also covered in Module 3, is what translates the allocation and diversification into concrete numbers: how much weight each position gets within the portfolio, consistent with its contribution to overall risk, not just with the investor's conviction in that specific idea.</p>\n<p>Finally, building a portfolio doesn't end at the moment of purchase. The tax cost of trades -- already covered in Module 5 -- and the future need to rebalance -- already covered in Module 4 -- are part of the criteria from the start, not an afterthought: a well-built portfolio anticipates that it will need to be reviewed over time, a topic the next lesson develops.</p>\n<h2>Example</h2>\n<p>An investor with a long time horizon and a risk profile that tolerates swings decides, based on their asset allocation, to put most of the portfolio into stocks and a smaller part into bonds. Within the stock portion, they diversify across several companies and sectors instead of concentrating the investment in just one; within the bond portion, they do the same across several issuers. Position weights have been set accounting for their contribution to concentration risk and how they relate to the rest of the positions.</p>\n<h2>Common mistakes</h2>\n<ul><li>Choosing the specific instruments first and deciding the asset allocation afterward, instead of the other way around -- the allocation should precede the selection, not follow it.</li><li>Confusing &quot;diversifying&quot; with &quot;accumulating many different instruments&quot; without watching the real correlation between them.</li><li>Building the portfolio without considering from the start that it will have a tax cost and will need rebalancing -- treating both as a later surprise instead of a design criterion.</li></ul>\n<h2>Summary</h2>\n<p>Building a real portfolio means applying, in sequence, the criteria already covered in this level: asset allocation based on risk profile and time horizon, diversification within and across asset classes, sizing each position based on its contribution to overall risk, and anticipating the tax cost and the future need to rebalance.</p>\n<h2>Self-check</h2>\n<p>Why should asset allocation be decided before choosing the specific instruments that will make up the portfolio?</p>\n<p>Why isn't diversifying the same as simply accumulating different instruments?</p>","sortOrder":1,"readingMinutes":7,"difficulty":"Intermedio","url":"/en/academy/portfolio-management/building-a-portfolio/how-do-you-build-an-investment-portfolio-step-by-step"}],"graphSummary":{"root":{"type":"concept","id":"83","depthFromRoot":0,"entity":{"type":"concept","slug":"correlacion","term":"Correlación","excerpt":"Tendencia de dos activos a moverse en la misma dirección, en direcciones opuestas o de forma independiente ante los mismos eventos -- el mecanismo real por el que diversificar reduce el riesgo de una cartera."}},"depth":1,"returnedNodes":1,"truncated":false,"hasCycle":false,"nodes":[{"type":"concept","id":"83","depthFromRoot":0,"entity":{"type":"concept","slug":"correlacion","term":"Correlación","excerpt":"Tendencia de dos activos a moverse en la misma dirección, en direcciones opuestas o de forma independiente ante los mismos eventos -- el mecanismo real por el que diversificar reduce el riesgo de una cartera."}}],"edges":[]},"relatedNews":[],"relatedEntities":[]}