Diversification
Spreading capital across assets so no single failure is fatal.
What is Diversification?
Holding uncorrelated or weakly correlated positions to reduce portfolio volatility without a proportional cut in expected return. It removes unsystematic risk; it cannot remove systematic risk.
Diversification: a worked example
Twenty stocks across sectors captures most of the diversification benefit of holding a hundred.
More terms in Risk & Return
Systematic Risk (Market Risk)
Risk affecting the whole market that diversification cannot remove.
Unsystematic Risk (Specific Risk)
Company- or industry-specific risk that diversification can eliminate.
Beta
How much a security moves relative to the overall market.
Alpha
Return above what the portfolio's risk exposure would predict.
Standard Deviation
How widely returns disperse around their average.
Sharpe Ratio
Excess return per unit of total volatility.
Correlation
How closely two assets move together, from -1 to +1.
Maximum Drawdown
The largest peak-to-trough decline over a period.