Understanding Index Fund Correlation
Correlation runs from -1 to +1, and two S&P 500 funds sit at roughly +0.99. Real diversification comes from pairing assets that don't move in lockstep — here's how to read the numbers.
Don't have time? Here's what you need to know:
- 1Correlation runs from -1 to +1; two S&P 500 funds sit near +0.99 and barely diversify each other.
- 2U.S. and international stocks still correlate strongly (~+0.8), so global stock funds offer less offset than many assume.
- 3High-quality bonds versus stocks have historically had near-zero or negative correlation — the strongest common diversifier.
- 4Owning more funds doesn't mean diversification; the correlation between them is what determines your real risk.
What Correlation Actually Measures
Correlation is a single number, between -1 and +1, that describes how two investments move relative to each other. A correlation of +1 means they rise and fall in perfect lockstep; -1 means they move in exact opposite directions; and 0 means their movements are unrelated. For index funds, this number tells you whether adding a second fund genuinely spreads your risk or just duplicates a bet you already hold.
The trap is assuming that owning several funds equals diversification. Two funds tracking the same large-cap U.S. market will post a correlation close to +0.99 — they are, for practical purposes, the same holding wearing a different ticker. Diversification only does work when correlations are meaningfully below 1, because that is when one asset can hold up while another falls.
Typical Correlations Between Major Asset Classes
The table below shows rough, long-run correlation ranges between common building blocks. These figures drift over time and can spike during a crisis — in the 2008 and March 2020 sell-offs, many risk assets briefly moved together as investors sold everything for cash — but the broad pattern is durable. U.S. and international stocks are highly correlated; high-quality bonds and stocks are much less so.
Notice that U.S. and developed international stocks still correlate strongly, often around +0.8. That is why an investor holding VOO plus VXUS gets some diversification benefit, but less than many expect. The clearest offset historically has come from pairing stocks with investment-grade bonds such as BND, whose correlation to equities is low and has often been negative when it mattered most.
| Asset pair | Typical long-run correlation |
|---|---|
| Two S&P 500 funds (e.g. VOO and IVV) | ~+0.99 |
| U.S. total market vs S&P 500 | ~+0.99 |
| U.S. stocks vs developed international stocks | ~+0.8 |
| U.S. stocks vs emerging-market stocks | ~+0.7 |
| U.S. stocks vs investment-grade bonds | ~0 to -0.2 |
| U.S. stocks vs gold | ~0 |
Why Near-Identical Funds Don't Diversify You
Holding two funds with a +0.99 correlation feels safer, but the math says otherwise. The risk reduction from combining assets depends almost entirely on how far their correlation sits below 1. Pair two holdings at +0.99 and your portfolio volatility barely changes — you have simply split one position across two line items.
This is the practical lesson for anyone who owns, say, an S&P 500 fund, a large-cap growth fund, and a Nasdaq-100 fund. All three are dominated by the same handful of mega-cap names and move together. You hold three tickers but carry the concentration of one. To genuinely lower risk you need exposure that zigs when your core holding zags, not three flavors of the same large-cap U.S. bet.
Important: A high fund count is not diversification. Five funds that all track U.S. large-caps behave like one fund — the correlation, not the number of tickers, is what determines your real risk.
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Building a Portfolio With Lower Correlations
The way to put correlation to work is to combine asset classes that respond differently to the same economic conditions. A classic example is the stock-bond pairing: when growth scares hit equities, high-quality bonds have often risen as investors seek safety and interest-rate cuts lift bond prices. That negative or near-zero correlation is what lets a balanced portfolio fall less in a downturn than an all-stock one.
A simple, well-diversified mix might combine a U.S. total-market fund like VTI, an international fund like VXUS, and a broad bond fund like BND. Each block carries a different correlation profile, so the whole is steadier than any single piece. The goal is not to chase zero correlation everywhere — it is to avoid stacking redundant, near-+1 positions on top of each other.
Tip: Before buying a second fund, ask what its correlation to your existing holdings is. If it's above roughly +0.9, you're adding overlap, not diversification.
Frequently Asked Questions
What is a good correlation for diversification?
Lower is better for diversification. A correlation below about +0.7 starts to provide meaningful risk reduction, and pairings near 0 or negative (like high-quality bonds versus stocks) provide the most. Two funds correlated above +0.9 are largely redundant — they move together, so combining them does little to lower your overall portfolio risk.
Are VOO and VTI too correlated to hold both?
Their correlation is roughly +0.99 because VTI is mostly the same large-cap companies as VOO plus a tail of mid- and small-caps. Holding both isn't harmful, but it's largely redundant — you're paying attention to two tickers that behave almost identically. Most investors pick one as their U.S. core rather than owning both.
Does correlation stay constant over time?
No. Correlations shift with the economic regime and can rise sharply in a crisis. In severe sell-offs like 2008 and March 2020, assets that are normally less correlated moved down together as investors sold everything for cash. This is why diversification helps most of the time but can offer less protection precisely when panic peaks.
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Alex Harrington
CFA Level II Candidate, Finance & Economics
Alex Harrington is an independent ETF researcher and personal finance writer with over 8 years of experience analyzing exchange-traded funds. A CFA Level II candidate with a background in economics, Alex has reviewed 800+ ETFs and helped thousands of beginners build their first investment portfolios through clear, jargon-free education.
This content is for educational purposes only and does not constitute financial advice. Past performance does not guarantee future results. Consult a licensed financial advisor before making investment decisions.