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Constant Ratio Planonstant Ratio PlanAn asset allocation strategy in which assetsn asset allocation strategy in which assetsare assigned a fixed ...re assigned a fixed ...

Burst Basketurst BasketA burst basket refers to a particular type of  burst basket refers to a particular type ofstock transaction ...tock transaction ...

Idiosyncratic Riskdiosyncratic RiskRisk that is specific to an asset or a smallisk that is specific to an asset or a smallgroup of assets. ...roup of assets. ...

Mutual Fundutual FundAn investment vehicle that is made up of an investment vehicle that is made up of apool of funds collected ...ool of funds collected ...

DEFINITION of 'Diversification'EFINITION of Diversification

A risk managementisk management technique that mixes atechnique that mixes a wide varietyide variety ofof investmentsnvestments

within a portfolio. The rationale behind this technique contends that aithin a portfolio. The rationale behind this technique contends that a

portfolioortfolio of different kinds of investments will, on average, yieldof different kinds of investments will, on average, yield

higher returns and pose a lower risk than any individual investmentigher returns and pose a lower risk than any individual investment

found within the portfolio.ound within the portfolio.

Diversification strives to smooth outiversification strives to smooth out unsystematic risknsystematic risk events in aevents in aportfolio so that the positive performance of some investments willortfolio so that the positive performance of some investments will

neutralize the negative performance of others. Therefore, the benefitseutralize the negative performance of others. Therefore, the benefits

of diversification will hold only if thef diversification will hold only if the securitiesecurities in the portfolio are notin the portfolio are not

perfectly correlated.erfectly correlated.

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CONSTANT RATIO PLANONSTANT RATIO PLAN BURST BASKETURST BASKET IDIOSYNCRATIC RISKDIOSYNCRATIC RISK  ASSET ALLOCATIONSSET ALLOCATION

BREAKING DOWN 'Diversification'REAKING DOWN Diversification

Studies and mathematical models have shown that maintaining a well-diversified portfolio of tudies and mathematical models have shown that maintaining a well-diversified portfolio of

25 to 30 stocks will yield the most cost-effective level of risk reduction.5 to 30 stocks will yield the most cost-effective level of risk reduction. Investingnvesting in morein more

securities will still yield further diversification benefits, albeit at a drastically smaller rate.ecurities will still yield further diversification benefits, albeit at a drastically smaller rate.

Further diversification benefits can be gained by investing in foreign securities because theyurther diversification benefits can be gained by investing in foreign securities because they

tend be less closely correlated with domestic investments. For example, an economicend be less closely correlated with domestic investments. For example, an economic

downturn in the U.S. economy may not affect Japan's economy in the same way; therefore,ownturn in the U.S. economy may not affect Japan s economy in the same way; therefore,

having Japanese investments would allow an investor to have a small cushion of protectionaving Japanese investments would allow an investor to have a small cushion of protection

against losses due to an American economic downturn.gainst losses due to an American economic downturn.

Most non-institutional investors have a limited investment budget, and may find it difficult toost non-institutional investors have a limited investment budget, and may find it difficult to

create an adequately diversified portfolio. This fact alone can explain whyreate an adequately diversified portfolio. This fact alone can explain why mutual fundsutual funds havehave

been increasing in popularity. Buying shares in aeen increasing in popularity. Buying shares in a mutual fundutual fund can provide investors with ancan provide investors with an

inexpensive source of diversification.nexpensive source of diversification.

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