Diversification benefit quantifies the risk reduction achieved by combining assets that don't move in perfect lockstep. Higher values indicate more effective diversification.
Formula
Div Benefit = (σ_undiversified - σₚ) / σ_undiversified × 100%Methodology
Diversification benefit is one of the key insights from Modern Portfolio Theory - that combining imperfectly correlated assets reduces overall risk below the weighted average of individual risks.
The calculation compares: 1. Undiversified volatility: Σᵢ wᵢσᵢ (assuming perfect correlation) 2. Actual portfolio volatility: √(Σᵢ Σⱼ wᵢwⱼσᵢσⱼρᵢⱼ)
A diversification benefit of 20% means your portfolio is 20% less volatile than it would be if all your holdings moved in perfect sync.
Factors that increase diversification benefit: - Holdings in different sectors - Mix of domestic and international assets - Combination of stocks and bonds - Assets with low or negative correlation
How to Interpret
| Range | Label | Meaning |
|---|---|---|
| ≥ 20 | Excellent | Highly effective diversification across your holdings |
| 10 to 20 | Good | Meaningful diversification benefits |
| 5 to 10 | Modest | Some diversification - consider adding uncorrelated assets |
| < 5 | Limited | Holdings are highly correlated - limited diversification |
Data Source
Compares actual portfolio volatility to the weighted-average volatility (as if assets were perfectly correlated).
Reference
Markowitz, H. (1952). Portfolio Selection. Journal of Finance, 7(1), 77-91
Limitations
Based on historical correlations which may increase during market stress. Diversification reduces but does not eliminate risk.
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For Educational Purposes Only
This analysis is not investment advice. Results are based on simplified models using historical data. Past performance does not guarantee future results. All investments carry risk of loss. Consult a qualified financial advisor before making investment decisions.