Volatility and correlation

Expected return describes the center of an investment assumption. Volatility and correlation describe how uncertain returns may be and how different investments may move together.

Volatility: how wide is the range?

Higher volatility means annual returns are modeled with a wider spread around the expected return. It does not mean every year will be poor. It means large gains and losses are more plausible.

Two investments can have the same expected return but create very different retirement outcomes if one is much more volatile—especially when withdrawals make early losses harder to recover from.

Correlation: what moves together?

Correlation describes the tendency of two return series to move in the same or different directions. A high positive correlation means they often rise and fall together. A lower or negative correlation means their movements are less aligned.

Combining assets that do not move in lockstep can reduce the portfolio’s overall fluctuations. That is the practical idea behind diversification. It does not prevent losses, and relationships can change during stressed markets.

Use the assumptions together

Return, volatility, and correlation form one model. Changing only the expected return while leaving the risk assumptions untouched can create an outlook that is internally inconsistent.

When comparing portfolios, look at the combination of expected return and risk rather than choosing the highest return. Also check whether diversification exists both across broad asset classes and within them. The SEC’s asset allocation and diversification guide provides a plain-language overview.