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Demonstrating Diversification With Stocks

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Diversification can be a tough concept to grasp especially when there are a lot of different definitions out there.

In this piece, we will demonstrate one form of diversification: stock selection. We will construct multiple $1 million portfolios of individual stocks and a $1 million portfolio that contains a basket of stocks. The basket of stocks provides diversification by slightly lowering the annualized returns but also significantly lowering the volatility when compared to a portfolio that contains one underlying.

The portfolios with oner underlying usually have a worse balance of risk and reward when compared to the portfolio with multiple uncorrelated stocks.

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