Diversification in finance involves spreading investments around into many types of investments, including stocks, mutual funds, bonds, and cash. Money can also be diversified into different mutual fund investment strategies, including growth funds, balanced funds, index funds, small cap, large cap, and sector-specific funds. Geographic diversification involves a mixture of domestic and international investments.

Diversification reduces the risk of a portfolio. It does not necessarily reduce the returns. This is why diversification is referred to as the only free lunch in finance.

Diversification can be quantified as the intra-portfolio correlation. This is a statistical measurement from negative one to one that measures the degree to which the various assets in a portfolio can be expected to perform in a similar fashion or not.

Intra-portfolio correlation	Percent of diversifiable risk eliminated
1	0%
.75	12.5%
.50	25%
.25	37.5%
0	50%
-.25	62.5%
-.50	75%
-.75	87.5%
-1	100%

Portfolio balance occurs as the sum of all intra-portfolio correlations approaches negative one. Diversification is thus defined as the intra-portfolio correlation or, more specifically, the weighted average intra-portfolio correlation. Maximum diversification occurs when the intra-portfolio correlation is minimized. Intra-portfolio correlation may be an effective risk management measurement. The computation may be expressed as:

$$

Q = \frac{\sum_{i=1}^n\sum_{j=1}^n X_i X_j P_{ij}}{\sum_{i=1}^n\sum_{j=1}^n X_i X_j}

Where Q is the intra-portfolio correlation, $X\_i$ is the fraction invested in asset i, $X\_j$ is the fraction invested in asset j, $P\_\{ij\}$ is the correlation between assets i and j, and n is the number of different assets.

See also

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• Modern portfolio theory
• List of finance topics

Statistics | Finance

Diversifikation | Diversification | Diversificazione (finanza) | Диверсификация