What does correlation between assets mean and why does it matter for diversification?

Correlation measures how two investments move relative to each other, on a scale from +1 to -1. A correlation of +1 means they move in lockstep; -1 means they move exactly opposite; 0 means no relationship. Diversification works best when you combine assets that aren't highly correlated, because when one zigs, another may zag, smoothing your overall ride.

This is why adding high-quality bonds to stocks helps: historically they've often had low or even negative correlation, so bonds can hold up or rise when stocks fall. The catch is that correlations aren't fixed; in severe crises, many risky assets become highly correlated and fall together, which limits diversification exactly when you want it most. So combine assets with genuinely different drivers, and don't assume a low correlation in calm markets will hold in a panic. That's why bonds and cash, not just more stocks, matter.