SkiptomaincontentBoundlessFinanceIntroductiontoRiskandReturnSearchfor:DiversificationImpactofDiversificationonRiskandReturn:UnsystematicRiskIngeneral,diversificationcanreduceriskwithoutnegativelyimpactingexpectedreturn.LearningObjectivesDescribeunsystemicriskKeyTakeawaysKeyPointsDiversificationisnotputtingallyoureggsinonebasket.Diversificationreliesonthelackofatightpositiverelationshipamongtheassets‘returns,andworksevenwhencorrelationsarenearzeroorsomewhatpositive.Thedebateoveractivevspassivemanagementisonethattakesonthelimitstodiversification.KeyTermsUnsystematicrisk:Unsystematicordiversifiableriskisatermgiventotheportionofriskinaportfoliothatcanbediversifiedawaybyholdingapoolofindividualassets.Didyourgrandmothereverwarnyounottoputallyoureggsinonebasket?Didyouknowwhatshewastalkingabout?Theimplicationisobvious.Ifyouputallyoureggsinonebasket,andthatbasketbreaks,youarestuckwithnothingtofryupintoanomelet.Grandmawasn’ttellingyoutogrowupandbeanomeletchef,shewasactuallygivingyousomesageadvicethatappliestoyourfutureasaportfoliomanager.Wehavetalkedaboutdiversificationpreviously,andthissectionwillfollowfromthat.Remember,wetalkedabouteveryparticularinvestmenthavinganexpectedreturnandavariance.Ifyouaremanagingapoolofassets,youwanttogetpositivereturnswithoutbeingindangerof“losingyourshirt.”Theprobabilitythatonestockgoesbellyupismuchhigherthanthatthewholestockmarketdoes.Infinance,systematicriskisthetermassociatedwithriskthatcanbediversifiedawaybyinvestinginabroaderpoolofassets.Diversificationreliesonthelackofatightpositiverelationshipamongtheassets’returns,andworksevenwhencorrelationsarenearzeroorsomewhatpositive.Ontheflip-side,hedgingisthetacticthatreliesonnegativecorrelationsamongassets.Diversificationcomeswithacostassociatedwithit,andsomemightpointoutthatitispossibletoover-diversify.Theideaisthatyoucanonlydiversifyawaysomuchrisk,thatthemarginalreturnsoneachnewassetaredecreasing,andeachtransactionhasacostintermsofatransactionfeeandalsoresearchcosts.Atsomepoint,itjustisn’tworth