Definition of Diversification

Diversification

Dividing investment funds among a variety of securities with different risk, reward, and
correlation statistics so as to minimize unsystematic risk.

Diversification

The process of spreading a portfolio over many investments to
avoid excessive exposure to any one source of risk

diversification

Strategy designed to reduce risk by spreading the portfolio across many investments.

Diversification

Investing so that all your eggs are not in the same basket. By spreading your investments over different kinds of investments, you cushion your portfolio against sudden swings in any one area. Segregated equity funds have become a popular and secure way for average investors to get the benefits of greater diversification.

diversification

An investment technique intended to minimize risk by utilizing a wide variety of investments within a portfolio. In a diversified portfolio, a decline in the value of one investment, for example, should be offset by the strength of other investments.

Efficient diversification

The organizing principle of modern portfolio theory, which maintains that any riskaverse
investor will search for the highest expected return for any level of portfolio risk.

International diversification

The attempt to reduce risk by investing in the more than one nation. By
diversifying across nations whose economic cycles are not perfectly correlated, investors can typically reduce
the variability of their returns.

Liquidity diversification

Investing in a variety of maturities to reduce the price risk to which holding long
bonds exposes the investor.

Magic of diversification

The effective reduction of risk (variance) of a portfolio, achieved without reduction
to expected returns through the combination of assets with low or negative correlations (covariances).
Related: Markowitz diversification

Markowitz diversification

A strategy that seeks to combine assets a portfolio with returns that are less than
perfectly positively correlated, in an effort to lower portfolio risk (variance) without sacrificing return.
Related: naive 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.

Principal of diversification

Highly diversified portfolios will have negligible unsystematic risk. In other
words, unsystematic risks disappear in portfolios, and only systematic risks survive.

Portfolio Diversification

See diversification

Capital asset pricing model (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.

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.

Nondiversifiable risk

Risk that cannot be eliminated by diversification.

Nonsystematic risk

Nonmarket or firm-specific risk factors that can be eliminated by diversification. Also
called unique risk or diversifiable risk. Systematic risk refers to risk factors common to the entire economy.

One-factor APT

A special case of the arbitrage pricing theory that is derived from the one-factor model by
using diversification and arbitrage. It shows the expected return on any risky asset is a linear function of a
single factor.

Passive portfolio strategy

A strategy that involves minimal expectational input, and instead relies on
diversification to match the performance of some market index. A passive strategy assumes that the
marketplace will reflect all available information in the price paid for securities, and therefore, does not
attempt to find mispriced securities. Related: active portfolio strategy

Systematic risk

Also called undiversifiable risk or market risk, the minimum level of risk that can be
obtained for a portfolio by means of diversification across a large number of randomly chosen assets. Related:
unsystematic risk.

Unique risk

Also called unsystematic risk or idiosyncratic risk. Specific company risk that can be eliminated
through diversification. See: diversifiable risk and unsystematic risk.

Unsystematic risk

Also called the diversifiable risk or residual risk. The risk that is unique to a company
such as a strike, the outcome of unfavorable litigation, or a natural catastrophe that can be eliminated through diversification.
Related: Systematic risk

Asset-specific Risk

The amount of total risk that can be eliminated by diversification by
creating a portfolio. Also known as company-specific risk or
unsystematic risk.

Market Risk

The amount of total risk that cannot be eliminated by portfolio
diversification. The risk inherent in the general economy as a
whole. Also known as systemic risk.

Systematic Risk

The amount of total risk that cannot be eliminated by portfolio
diversification. The risk inherent in the general economy as a
whole. Also known as market risk.

Unsystematic Risk

The amount of total risk that can be eliminated by diversification by
creating a portfolio. Also known as asset-specific risk or
company-specific risk.

Market Risk

The part of security's risk that cannot be eliminated by diversification. It is measured by the beta coefficient.

mutual fund

When you buy a mutual fund, you are pooling your money with that of other investors. An investment professional called a portfolio advisor takes that money and invests it for all the investors in a variety of different securities as determined by the investment objectives of the mutual fund. This gives you the benefit of diversification that is, being invested in many different investments at once.

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