In 2022, investors saw firsthand how correlation risk can play out when markets turn. As inflation rose and central banks tightened monetary policy, both U.S. and international equities suffered heavy losses. The S&P 500 fell about 18%, while the MSCI ACWI ex USA IMI dropped 16.15%.

For many, this was a wake-up call. Portfolios that looked diversified on paper were hit harder than expected because global equity correlations spiked, reducing the diversification benefits investors had been relying on. The Bank for International Settlements (BIS) notes that stress periods often increase co-movements across markets, which can further erode portfolio resilience.

This episode highlights why it’s important to use tools that can spot hidden correlation risks before they show up in performance.

Key Takeaways

• More holdings do not always mean more protection — correlated assets can still fall together.
• Large-cap tech stocks, certain cryptocurrencies, and sector-specific ETFs often show high correlation.
• Correlation risk can rise during periods of market stress, compressing diversification benefits.
• Investors can use tools and data to monitor overlap and build portfolios with truly distinct risk exposures.

The Illusion of “More is Better”

It’s common to believe that owning multiple assets from different tickers or funds guarantees better diversification. However, what matters more than quantity is correlation — the statistical relationship between how those assets move.

When markets are calm, assets may not move together much. But during stressful times, they often start moving in the same direction, so different investments can lose value at once. This is why a portfolio that looks diversified might act like a single big bet during a downturn, just when you need protection the most.

Common Offenders: Assets That Often Move Together

Certain asset classes are more prone to moving in sync, reducing the diversification benefit:

• Large-Cap Tech Stocks — Companies in the same sector can often share similar drivers, such as interest rate sensitivity or advertising trends. Even if they operate in different industries (cloud computing vs. social media), market sentiment can move them together.
• Correlated cryptocurrencies: Many digital assets, even with different names, often follow Bitcoin’s price movements, especially when the market is selling off.
• Sector-specific ETFs: Funds that focus on one industry, such as energy or financials, usually move in line with that sector’s performance, no matter what’s happening in the wider market.

When Correlation Risk Spikes

Hypothetical: Picture an investor who owns five different large-cap tech stocks, a technology ETF, and a popular cryptocurrency. If interest rates rise and trigger a market correction, all of those positions could decline at the same time. The sharper drawdown wouldn’t come from the number of holdings, but from their overlapping exposure.

Now, think about your own portfolio. If three of your top five positions each dropped 25%, what would that mean for your strategy? Asking this kind of question can be a useful way to gauge whether your diversification is as strong as it looks on paper.

According to the CFA Institute, cross-asset correlations can increase dramatically in crises as investors liquidate risk assets indiscriminately. This reinforces the need for proactive monitoring, because correlation is not static — it shifts with market cycles, economic shocks, and investor behavior.

Monitoring Overlap: Tools and Tactics

Some investors use AI-driven platforms like PortfolioPilot.com to calculate a portfolio’s diversification score, analyze sector exposure, and identify when multiple holdings share the same underlying risk drivers. By reviewing these metrics regularly, it’s possible to catch redundancy before it undermines portfolio resilience.

Even without advanced tools, simple practices can help:

• Reviewing sector weightings in mutual funds or ETFs
• Checking historical correlation data for major holdings
• Comparing performance patterns during past downturns

Correlation should be reviewed periodically, because relationships between assets can change over time. A pair of assets with low correlation today could move in near lockstep during the next market shock.

Final Insight: True diversification isn’t about owning more positions — it’s about owning different risk exposures. Identifying and reducing correlation risk, and reviewing it periodically can help portfolios remain effective through changing market environments