Diversification is a risk management system that blends a wide assortment of investments inside a portfolio. The rationale behind this technique contends that a portfolio constructed of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio (Staff, 2018). It is also defined as the process of investing in various assets or sectors, to reduce the non-symmetric risk. Whereas rick can be defined as the changes which can occur in the actual return from the expected return. Any kind of investments are associated to risk. "There are two types of risk, Unsystematic and systematic risk. Systematic Risks are those risks that affect the entire market. Whereas Unsystematic risk are those risks that are unique to the company. Diversification can help investors in reducing their Unsystematic Risk” (Bakri, 2014).
Diversification reduces the risk factor. This is likewise upheld by Portfolio Theory by Harry Markowitz, which expressed that financial specialists can build portfolios to optimize or maximize return at a given market risk (Markowitz, 1952). When we diverse, the normal return may diminish yet the risk factor additionally decreases altogether. Diversification of risk in the asset determination process enables the investors to decrease risk by combining negative corresponded resources with the goal that the risk of the portfolio is not as much as the risk of the individual asset. Regardless of whether resources are not adversely associated, the lower the positive connection between them, the lower the subsequent dangers. It also reduces the risk associated with the portfolio of the assets. The risk decreases below the weighted average risk of the individual asset, since when resources are consolidated together in a gathering or portfolio, extraordinary returns in a single course from one asset might be balanced by outrageous returns the other way from another asset.
Let’s make an assumption, to portfolio A and B having different assets along with different expected risk with same amount of cash
particular
Portfolio A
Portfolio B
Expected return(Er)
9%
13%
Variance
205
182.5
Standard Deviation (Sd)
14.32
13.51
Weightage(W)
0.5
0.5
Calculating the expected portfolio, E(rp)= WaE(Ra) + WbE(Rb)
= 0.59+0.513
= 11%
Standard deviation = Wa* SD of A +Wb * SD of B
= 0.514.32 + 0.5 13.51
= 13.91
Variance of the portfolio = √13.91
= 3.63
11% is the expected return from the portfolio and 13.91% is the standard deviation which implies the risk of the portfolio. Whereas the variance is 3.63, which the portfolio doesn’t consist of large asset and security.
Bakri, A. A. (2014). Portfolio Diversification Strategy and the Impacts on the Middle East Real Estate Investment Decision. International Journal of Economics and Finance Vol.6, No.2, 62-74.
Markowitz, H. (1952). Portfolio Selection. The Journal of Finance,Vol.7,No.1 , 77-91.
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Diversification is a risk management system that blends a wide assortment of investments inside a portfolio. The rationale behind this technique contends that a portfolio constructed of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio (Staff, 2018). It is also defined as the process of investing in various assets or sectors, to reduce the non-symmetric risk. Whereas rick can be defined as the changes which can occur in the actual return from the expected return. Any kind of investments are associated to risk. "There are two types of risk, Unsystematic and systematic risk. Systematic Risks are those risks that affect the entire market. Whereas Unsystematic risk are those risks that are unique to the company. Diversification can help investors in reducing their Unsystematic Risk” (Bakri, 2014).
Diversification reduces the risk factor. This is likewise upheld by Portfolio Theory by Harry Markowitz, which expressed that financial specialists can build portfolios to optimize or maximize return at a given market risk (Markowitz, 1952). When we diverse, the normal return may diminish yet the risk factor additionally decreases altogether. Diversification of risk in the asset determination process enables the investors to decrease risk by combining negative corresponded resources with the goal that the risk of the portfolio is not as much as the risk of the individual asset. Regardless of whether resources are not adversely associated, the lower the positive connection between them, the lower the subsequent dangers. It also reduces the risk associated with the portfolio of the assets. The risk decreases below the weighted average risk of the individual asset, since when resources are consolidated together in a gathering or portfolio, extraordinary returns in a single course from one asset might be balanced by outrageous returns the other way from another asset.
Let’s make an assumption, to portfolio A and B having different assets along with different expected risk with same amount of cash
Calculating the expected portfolio, E(rp)= WaE(Ra) + WbE(Rb)
= 0.59+0.513
= 11%
Standard deviation = Wa* SD of A +Wb * SD of B
= 0.514.32 + 0.5 13.51
= 13.91
Variance of the portfolio = √13.91
= 3.63
11% is the expected return from the portfolio and 13.91% is the standard deviation which implies the risk of the portfolio. Whereas the variance is 3.63, which the portfolio doesn’t consist of large asset and security.
References
Staff, I. (2018). Diversification . Retrieved from Investopedia: investopedia.com/terms/d/diversifi... 1
Bakri, A. A. (2014). Portfolio Diversification Strategy and the Impacts on the Middle East Real Estate Investment Decision. International Journal of Economics and Finance Vol.6, No.2, 62-74.
Markowitz, H. (1952). Portfolio Selection. The Journal of Finance,Vol.7,No.1 , 77-91.