Question

why does portfolio risk go down when you include more financial assets in a portfolio?

Answer 1

Ans:

The portfolio risk goes down when we include more financial asset in the portfolio.

Reason:

As we include more financial assets in a portfolio we are diversifying the portfolio and reducing the risk. The risk in investing is of two types: Un-diversifiable risk, this is the market risk and is caused by the market conditions like exchange rates, interest rates, inflation etc, this is not specific to any particular stock or industry and hence, this risk can’t be reduced and is faced by all investor,

On the other hand, the Diversifiable risk, is specific to company, economy, and this can be reduced by diversification, that is when we add more financial assets in the portfolio, as this will lower the volatility (standard deviation) of the portfolio as every other financial asset has different volatility and therefore, if we hold portfolio of non correlated financial assets then this type of risk would be a eliminated,

As this specific risk (unsystematic risk) is reduced, will decrease the overall volatility (risk) of the portfolio because different financial assets will rise and fall at different times and which will eventually smooth the returns of the portfolio as well.