Covariance

Covariance is a way to determine how two investments are linked, in terms of whether they both grow (or lose value) at the same time...or whether one investment grows in value while the other loses value.

A positive covariance between two investments means they’ll both grow (or lose value) more or less linearly together. A negative covariance means that, as one investment grows in value, the other will lose value, also more or less linearly. A zero covariance means, well...just that they don’t follow a linear pattern and/or don’t always increase or decrease together, or that they head in opposite directions.

Investors almost always want a portfolio without a bunch of investments that all have a positive covariance with each other. Because if one heads south, they all probably will. That’s bad. A well-diversified portfolio will have a decent amount of negative covariance pairs to protect the whole shooting match from tanking at once if that particular market (or markets) tank.