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.