Risk Reduction by Diversification of Porfolio

Advisors and investors would do well to pay as much attention to the expected volatility of any portfolio or investment as they do to anticipated returns. Moreover, all things being equal, a new investment should only be added to a portfolio when it either reduces the expected risk for a targeted level of returns, or when it boosts expected portfolio returns without adding additional risk, as measured by the expected standard deviation of those returns. Lesson 2: Don’t assume bonds or international stocks offer adequate portfolio diversification. As the world’s financial markets become more closely correlated, bonds and foreign stocks may not provide adequate portfolio diversification. Instead, advisors may want to recommend that suitable investors add modest exposure to nontraditional investments such as hedge funds, private equity and real assets. Such exposure may bolster portfolio returns, while reducing overall risk, depending on how it is structured. Lesson 3: Be disciplined in adhering to asset allocation targets. The long-term benefits of portfolio diversification will only be realized if investors are disciplined in adhering to asset allocation guidelines. For this reason, it is recommended that advisors regularly revisit portfolio allocations and rebalance

“The Benefits of diversification are clear. Portfolio theory has played a crucial role in explaining the relationship between risk and return where more than one investment is held. It also enables us to identify optimal and efficient portfolios.”

Diversification is a basic principle in investing the idea being that since you cannot possibly know beforehand which stocks will perform better or worse than the average, you cannot afford to put all of your money into one company, or even in companies within a single industry. One resorts to diversification to spread the risk -- and opportunity. The average returns are obtained by diversifying.

The idea behind diversification is to invest in a large number of assets so that a loss in any particular investment is minimized by gains

It would be great to live in a world where investing provided guaranteed payout with little or no risk, however, we all realize that is not the way investing works. Generally, the greater the risk, the greater potential for return or worse, loss. How we perceive and respond to risk is a very personal decision and there are several factors that go into making that decision. In this paper, I will discuss the risk of stock investing. There are two types of risk involved in investing in stock. One is diversifiable risk and is completely controlled by the investor. It means that a portfolio should be filled with stocks of varying degrees of risk. The other type of risk is market risk. The

Theoretically, portfolio theory arguments suggest that the imposition of additional constraints will inhibit the construction of the optimal portfolio. As the universe of investment is reduced, investors will benefit less from the potential for diversification than in an unconstrained portfolio which will result in lower risk-adjusted returns. Furthermore, the additional costs of monitoring social performance might also cause socially responsible funds to underperform.

Recent studies show that they are different definitions and purpose of asset allocation within different groups of investors. For professional investors, asset allocation usually means (i) calculating the rates of return between various asset classes, (ii) running these variables to select asset mixes with different risk and return profiles; and (iii) analyzing and implementing the desired asset allocation. Whilst

The goal of this paper is to explain why CCM’s aggressive program is a good alternative to any investor looking to diversify its portfolio. The paper will be divided in three distinct parts: the operational analysis, the quantitative analysis and a comparison against its peers (including the impact of CCM in a traditional portfolio).

“The concept of efficient diversification implies that for an investor wishing to efficiently assume risk in their portfolio; the risky part of the portfolio should consist of weighted proportions of all possible risky assets.”

Investors and financial scholars describe the systematic risk – also known and non-diversifiable risk- as the component of an investment that is totally related to the return from the market (Hull, 2015, p. 8). In other words, it depends on the conditions of the market, which is affected by the inflation rate, exchange rate, interest rate and economy growth rate (Atrill, 2014, p. 215).

Diversification is a method of investing that been shown to increase portfolio return while reducing portfolio risk as measured by standard deviation. This method specifically increases the efficient frontier for investors. The challenge to an investing firm is an appetite by its customers for an ever increasing efficient frontier. One area to explore to obtain this increase is through further diversifying through international diversification.

“Market wide new is news about the economy as a whole and therefore affects all stocks. For instance, the federal reservce might announce that it will lower interest rates to boost the economy” (311). Fluctuations of a stock's return that are due to market wide news are common risk. All stocks are affected by this news. Common risk is also referred to as systematic risk. Since systematic risk affects all firms, it cannot be eliminated through diversification.

Standard deviations are an indicator of market volatility and represent risk. The lower standard deviations, the lower risks of portfolios. Even though the expected market return of active portfolio does not perform well, the risk of active portfolio is minimized. There is no short selling in the active portfolio and the the active portfolio is diversified through balanced investment of these ten stocks. Furthermore, the weights of 10 stocks in the active portfolio are more balanced than the passive portfolio. Therefore, the investors who pursue high expected market return should choose passive portfolio and risk averse investors should choose active portfolio. The investors should consider transaction fees and management fees of active portfolio and investors can insist on choosing active portfolio if they believe they can have higher return that offset these fees.

If the assets exist to help meet a liability, the liability should be considered in the process; 3. Basing one’s decision solely on an asset allocation’s mean and variance is insufficient to base one’s decisions, in a world in which asset class returns are not normally distributed; and, 4. Most investors have multi-period objectives and the mean-variance framework is a single period model. These potential shortcomings are the likely reasons that practitioners have not fully embraced meanvariance optimization. For a number of practitioners, mean-variance optimization creates the illusion of quantitative sophistication; yet, in practice, asset allocations are developed using judgmental, ad hoc approaches. Recent advances significantly improve the quality of typical mean-variance optimizationbased asset allocations that should allow a far wider audience to realize the benefits of the Markowitz paradigm, or at least the intent of the paradigm. In this article, we focus on the first issue: the lack of diversification that can result from traditional meanvariance optimization. We begin with two examples in which traditional mean-variance optimization

Next, the diversification is the idea of “not putting all of your eggs in one basket”. The investors can decrease the risks of their investments by