Diversification (Advanced)
InvestingGlossary term
Definition
The practice of spreading investments across multiple asset classes, sectors, geographic regions, and investment styles to reduce portfolio risk. True diversification goes beyond owning many stocks to include assets with low or negative correlations to each other.
Related terms
- Correlation (Investing)A statistical measure of how two investments move in relation to each other, ranging from -1 (perfect inverse) to +1 (perfect sync). Low or negative correlation between assets is the foundation of diversification, as losses in one may be offset by gains in another.
- Asset ClassA group of investments that share similar characteristics and behave similarly in the marketplace. The major asset classes include stocks, bonds, real estate, commodities, and cash equivalents. Diversifying across asset classes reduces portfolio risk.
- Modern Portfolio TheoryA framework developed by Harry Markowitz that shows how investors can construct portfolios to maximize expected return for a given level of risk through diversification. The theory demonstrates that portfolio risk depends not just on individual assets but on how they correlate.
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