Financial Management: Core Concepts, Third Edition

8.7 Diversification: Minimizing Risk or Uncertainty

We have learned that risk is a measure of the uncertainty about future events in which one or more of the potential outcomes result in a loss. Is there a way to lower or minimize risk without giving up return potential? As you saw at the beginning of this chapter, the old adage “Don’t put all your eggs in one basket” is one possible answer. If eggs are dollars for investment and baskets are investment opportunities, the proverb means that you should put your investment dollars into different assets so that if one should fail, the others remain intact, preventing disaster. The modern-day equivalent of this proverb is “Diversify your investments."

In a diversified portfolio, the money invested ...