What Diversification Really Means

Abstract

Diversification is not an end unto itself. More and more diversification is not necessarily helpful at all. The thing is, concentration adds to return and diversification removes risk, but both only to a point. So which is it that you need, a more concentrated or a more diversified portfolio? This is a question without an answer. There is no science to balancing these two—just art. As we will see in the chapter on allocation process, we can determine if an added manager reduces risk or not and by how much. We also can see what effect the new investment may have on the expected return and the right (good) side of the return distribution, but when is enough enough? The easy answer is that it depends. Certainly once a new investment stops subtracting risk or adding return, you have reached enough. Before that point however, it will only be your sense that your efforts toward risk and return have balanced one another.