# Diversification

Diversification is behind the equation 1 + 1 = 1.41. Let's start with a simple example. Suppose you make the investment described in the example in Chapter 1 that pays out \$1 with a 50 percent probability and \$3 with a 50 percent probability. The expected payout will be \$2 [(50% × \$1) + (50% × \$3)]. The standard deviation (the most common measure of volatility) of the payout is defined as the square root of the expected squared deviation from the mean. (Chapter 1 uses the average absolute return rather than the standard deviation, for simplicity.) Under either outcome, the squared deviation from the mean of \$2 is \$1, so the expected squared deviation is \$1, and the square root of this is also \$1.

Now suppose you invest ...

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