Finding the right mix of investments

A key idea in putting together a portfolio of investments is to manage risk by having different types of investments that don't all move in the same direction at the same time. This is called correlation.

If your bonds and your stocks move in lockstep, what good is that?

Jonelle Marte explains in The Wall Street Journal how correlation is measured.

Correlation is determined by comparing the returns or general movements of two assets or products. Using what's called a regression analysis, an adviser produces a number, from 1 to negative 1, that displays how likely one asset is to move similarly to another.

A correlation close to zero means the performance of one asset has little or no connection to that of the other. A correlation of 1 is a perfect positive correlation, meaning the two assets always move in sync—in the same direction, and at a scale that doesn't vary. For instance, Asset A will always move at twice the magnitude of Asset B. A correlation of minus 1 is a perfect negative correlation. The assets move in opposite directions at a scale that doesn't vary.

Here is the strategy:

A key aim of asset allocation is to invest across a range of sectors, countries and asset classes that earn decent returns but are relatively uncorrelated. That way, if one asset in a portfolio suffers, the rest might be unaffected. For example, Treasury inflation-protected securities, or TIPS, usually move unrelated to the performance of the S&P 500.

You will likely need to get correlation data from a financial adviser, but here are two sources for ordinary folk:

Tools for individuals include assetcorrelation.com, which finds correlations between assets and between asset classes.

R-squared, a measure found on Morningstar.com, shows strength of correlations between funds and benchmark indexes, but not directions of movement. The scale ranges from 0 to 100.