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Can you actually (easily?) quantify the value added to an investment portfolio by diversifying it? |
I am hoping to end up with a simple number such as "80 basis points". Of course, if that is not possible then we will take whatever answer is the truth. There is no value added by diversification (all things being equal). You are trying to reduce your risk. You have to identify the risk, or beta, for any given stock you hold. If you were to trade that stock for another, you subtract one beta from the other, and there's your quantified answer. The Sharpe Ratio can do what you want. The Sharpe Ratio is equal to the expected excess return divided by the standard deviation. Diversifying does not increase or decrease the value of a portfolio, it merely reduces the risk and extent of wild fluctuations in its value. You get greater safety at no extra cost. Well worth having. |
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