Correlation is a measure for how closely the market price of one ETF follows the market price of another. In our case, we always calculate how closely the market price of a given ETF follows the market price of SPY, an ETF that tracks the S&P 500. A correlation of 1.00 means that an ETF precisely tracks the movements of SPY. Similarly, a correlation of -1.00 means that an ETF precisely tracks the inverse movements of SPY.
Correlation is primarily a tool to build diversified portfolios for the long-term. Most people tend to prefer a stable portfolio that generates solid, consistent returns. It takes a portfolio of ETFs with different correlation levels to produce such a portfolio, as the markets go in cycles. Some years, the U.S. stock market performs well, while other years emerging market stocks perform well. Some years value stocks work well, while other years growth stocks work well. Also, ideally, if your portfolio includes some ETFs that are not closely correlated with SPY, your portfolio will perform better during the next market correction, as hopefully not everything in your portfolio will crash as much as SPY.
Our calculations are done in the following manner:
Here are the correlations of some ETFs that we have chosen just to illustrate what different correlations look like.
SMDV's correlation to SPY is 0.8467
SPLV's correlation to SPY is 0.9860
USL's correlation to SPY is -0.6647
EEM's correlation to SPY is 0.4624
All data is a live query from our database. The wording was last updated: 01/25/2017.
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