Diversification

Diversification is a risk-management strategy that spreads investment exposure across assets whose returns are not perfectly correlated. It can reduce portfolio-specific risk without necessarily reducing expected returns.

Correlation: A statistical measure of how two variables move together. Lower return correlation between holdings generally makes their combined portfolio less volatile.
Asset allocation: The distribution of investments among asset classes such as stocks, bonds, and cash. Diversification operates through choices about how much exposure each asset class receives.
Index fund: A fund designed to track the performance of a specified market index. Broad index funds provide exposure to many securities through a single holding.
Concentration risk: The risk arising when a portfolio depends heavily on a small number of investments or exposures. It is the portfolio condition diversification is intended to reduce.
Portfolio variance: The variance of returns across a portfolio, accounting for asset weights and covariances. It quantifies how asset relationships affect the risk diversification can reduce.
Portfolio: A collection of financial assets held by an investor or institution. Diversification describes how risk is managed across this broader investment collection.
International diversification: The practice of investing across countries and regions to spread geographic exposure. It extends portfolio diversification beyond the risks and returns of one national market.
Home bias: An investor’s tendency to favor domestic securities over foreign investments. It can leave a portfolio geographically concentrated despite holding many domestic securities.
Covariance: A measure of how two variables vary together. Portfolio risk depends on covariances among asset returns, not only each asset’s individual risk.
Expected return: The probability-weighted average return anticipated from an investment or portfolio. Diversification changes portfolio risk, while expected return depends on the holdings and their weights.

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