risk
Correlation Goes To One
The rule
In a crisis, things that usually move apart suddenly fall together. So spreading your money protects you least exactly when you need it most.
Where it flips
Pushed too far, this becomes an excuse to hold only cash and never invest, since 'everything falls together anyway'. The fix is to size your holdings so a shared fall is survivable - keep enough cash and staying power that you are never forced to sell into the panic - rather than dropping the spread of holdings entirely.
On a calm day your different stocks, funds and bonds seem to have minds of their own - one rises while another dips, and that spread feels like safety. But panic is one single feeling. When it arrives, everyone sells everything at once to raise cash, so prices that seemed unrelated fall in step. The comfort you built from 'many different bets' was measured in good weather, and it quietly vanishes in the storm.
A worked example
Rohan holds a large-cap fund, a mid-cap fund and a gold-mining stock, believing they cushion each other. In a March crash all three drop 30-40% in the same three weeks, as investors dump whatever they can. [illustrative]
How to spot it
- ·Your 'safe mix' was only ever tested in a rising market
- ·Everything you own is red on the same day
- ·You assumed two holdings were unrelated without checking a past crash
Roger Lowenstein · When Genius Failed