• Dividing investment funds among a variety of securities with different risk, reward, and correlation statistics so as to minimize unsystematic risk.
• Dividing investment funds among a variety of securities offering independent returns.
• In order to reduce risk, it is wise to own the best company in at least 10 industries, depending upon the size of your portfolio. Choose industries that are likely to have better growth than the economy as a whole.
Another way to diversify is to buy companies of various sizes in different industries. Size can be measured by the dollar figure for sales, (up to $400M = small company; above $4Billion = large company; middle-sized companies are in between.)
• It refers to spreading the risks. Diversification occurs when investors buy many different stocks and bonds instead of putting all of their money in a single stock. Similarly, banks can diversify their loans geographically by making loans across the globe instead of a single town.
• A strategy that aims to reduce risk, involving the spreading of assets across a mix of companies, investments, industries, geographic areas, maturity dates, and/or other investment categories.
| ||Embedded terms in definition|
| ||Referenced Terms|
| ||Capital asset pricing model: Abbreviated CAPM. The basic theory that links together risk and return for all assets. The CAPM predicts a relationship between the required return, or cost of common equity capital, and the nondiversifiable risk of the firm as measured by the beta coefficient.Abbreviated CAPM. An economic theory that describes the relationship between risk and expected return, and serves as a model for the pricing of risky securities. The CAPM asserts that the only risk that is priced by rational investors is systematic risk, because that risk cannot be eliminated by Diversification. The CAPM says that the expected return of a security or a portfolio is equal to the rate on a risk-free security plus a risk premium.Is a tool that relates an asset's expected return to the market's expected return. It combines the concepts of efficient capital markets with risk premiums. The idea of capital market efficiency assumes immediate instantaneous -response to perfect or near perfect information. The risk premiums relate an investment to the market's risk-free or riskless rate of return. Typically, this risk-free rate is viewed in terms of principal safety for short term U.S. government obligations. Here, beta relates the volatility of an asset to the market.|
| ||Diversifiable risk: Related: unsystematic risk.The portion of an asset's risk that is attributable to firm-specific, random causes; can be eliminated through Diversification.|
| ||Hedging demands: Demands for securities to hedge particular sources of consumption risk, beyond the usual mean-variance Diversification motivation.|
| ||Modern portfolio theory: Principles underlying the analysis and evaluation of rational portfolio choices based on risk-return trade-offs and efficient Diversification.|
| ||Naive diversification: A strategy whereby an investor simply invests in a number of different assets and hopes that the variance of the expected return on the portfolio is lowered. Related: Markowitz Diversification.|
| ||Related Terms|
| ||Efficient diversification|
Magic of diversification
Principal of diversification