2.3 Risk of Multiple Assets (Portfolio
"Put all your
eggs in one basket,
and then pay very close attention to that basket."
Why are we told not to put all our eggs in one basket?
If we had two baskets and we tripped, might we not lose
both baskets anyway? Or if we tripped, but caught ourselves
with our right hand, might we not save the full basket
in our left hand? What are the assumptions implicit
in the eggs-in-one-basket dictum ?
- Portfolio theory
Risks do not exist in isolation. An event that may
have an adverse effect on one financial asset may have
a beneficial effect on another. Risk should be seen
as affecting the overall returns of a group -- or portfolio
-- of assets. (More 2.3.1>>)
2.3.2 - Covariance defined
As we have seen, for diversification to work there
cannot be a perfect correlation between the returns
on different assets. When one is down, the other must
be up -- and vice versa. (More 2.3.2>>)
2.3.3 - Diversification
Combining negatively correlated assets can reduce the
overall variability of returns -- or risk as measured
by (lower-case sigma). This is known as diversification.
My ventures are not in one bottom trusted,
Nor to one place: nor is my wole estate
Upon the fortune of this present yea:
Therefore my merchandise makes me not sad.
Act 1, Scene 1