Why is it important to invest in a diversified portfolio? Which stock risk measure should you...

Why is it important to invest in a diversified portfolio? Which stock risk measure should you care about if you have a diversified portfolio? Can you eliminate all portfolio risk?

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Expert Solution

Market consists of different sectors with different volatility and predictibility. This is always said that we should not keep all eggs in one basket because if the basket will fall, your all eggs will be broken. Same is the case with the portfolio, you should always invest in a diversified portfolio since it minimises your loss when there is downfall in 1 sector like IT, healthcare etc.

Stock risk measure for a diversified portfolio depends upon 2 things i.e. risk and return. Stock risk measures that calculate these two factors together are Treynor, Sharpe and Jensen's Ratio.

There are 2 types of portfolio risk i.e. systematic risk and unsystematic risk. Unsystematic risk can be reduced or removed by diversification of portfolio. But, systematic risk is depended on market factors like political reasons, strike in healthcare sector by doctors, economic breakdown of country etc. which cannot be removed and will definitely affect your portfolio. Since, systematic risk cannot be eliminated, all portfolio risk cannot be eliminated.

jeff jeffy answered 1 year ago

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