Diversification is a measure of the commonality of a population. Greater diversification denotes a wider variety of elements within that population. Diversification is of central importance in investments. Diversification reduces the risk of a portfolio. It does not necessarily reduce the returns. This is why diversification is referred to as the only free lunch in finance. // Definition Investment or investing is a term with several closely-related meanings in finance and economics. ... In finance, a portfolio is a collection of investments held by an institution or a private individual. ... TANSTAAFL is an acronym for the adage There Aint No Such Thing As A Free Lunch, popularized by science fiction writer Robert A. Heinlein and promulgated in his 1966 novel The Moon is a Harsh Mistress, which deals with a libertarian utopia. ...
Diversification can be quantified as the intra-portfolio correlation. This is a statistical measurement from negative one to one that measures the degree to which the various assets in a portfolio can be expected to perform in a similar fashion or not. In probability theory and statistics, correlation, also called correlation coefficient, is a numeric measure of the strength of linear relationship between two random variables. ... It has been suggested that Definiton of asset be merged into this article or section. ...
Intra-portfolio correlation
Percent of diversifiable risk eliminated
1
0%
.75
12.5%
.50
25%
.25
37.5%
0
50%
-.25
62.5%
-.50
75%
-.75
87.5%
-1
100%
Portfolio balance occurs as the sum of all intra-portfolio correlations approaches negative one. Diversification is thus defined as the intra-portfolio correlation or, more specifically, the weighted average intra-portfolio correlation. Maximum diversification occurs when the intra-portfolio correlation is minimized. Intra-portfolio correlation may be an effective risk management measurement. The computation may be expressed as:
Where Q is the intra-portfolio correlation, Xi is the fraction invested in asset i, Xj is the fraction invested in asset j, Pij is the correlation between assets i and j, and n is the number of different assets.
Capital Market Line Modern portfolio theory (MPT) proposes how rational investors will use diversification to optimize their portfolios, and how an asset should be priced given its risk relative to the market as a whole. ... What follows is a list of over 250 Wikipedia articles on finance topics. ...
Diversification strives to smooth out unsystematic risk events in a portfolio so that the positive performance of some investments will neutralize the negative performance of others.
Therefore, the benefits of diversification will hold only if the securities in the portfolio are not perfectly correlated.
Further diversification benefits can be gained by investing in foreign securities because they tend be less closely correlated with domestic investments.
But before you hire anyone to help you with these enormously important decisions, be sure to do a thorough check of his or her credentials and disciplinary history.
Diversification is a strategy that can be neatly summed up by the timeless adage "Don't put all your eggs in one basket." The strategy involves spreading your money among variousinvestments in the hope that if one investment loses money, the other investments will more than make up for those losses.
Because achieving diversification can be so challenging, some investors may find it easier to diversify within each asset category through the ownership of mutual funds rather than through individual investments from each asset category.
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