In this case, assets that have a positive correlation can be combined with an aim of reducing risk. Hence, that ensures that none of the returns of the portfolio is forfeited. That remains the case even if the risk associated with individual assets is high. According to Markowitz, diversification needs to be done strategically. In this case, an entrepreneur should invest in assets in different industries Strong, , p. For instance, the investor should buy shares in manufacturing, mining, and service sectors.

The reason for that is that companies that sell the same goods or services occasionally perform poorly and hence investors that diversify their portfolios by buying assets in the same industry stand to lose. Conversely, by investing in different sectors, poor performance in one industry does not affect the returns from other industries. The significance of diversification can be illustrated using a portfolio containing two investment assets, A and B. In this case, the expected return of the portfolio E rp can be determined by the following calculations.

This means that by investing in two different assets from different industries, the entrepreneur gains favorable returns from the portfolio. Thus, diversification of the portfolio improves the expected returns. Complete Chapter List. You will have access to all course materials except graded items. Paid plan: Commit to earning a Certificate—it's a trusted, shareable way to showcase your new skills. What should the price of a stock be? How can we discover and exploit the relationships between equity prices automatically?

You will learn many of the principles and algorithms that hedge funds and investment professionals use to maximize return and reduce risk in equity portfolios. Tucker Balch, Associate Professor School of Interacti… Read the complete description Frequently asked questions There are no frequently asked questions yet. If you have any more questions or need help, contact our customer service. Didn't find what you were looking for?

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