The Diversification Ratio Calculator helps investors and financial analysts measure the effectiveness of diversification in a portfolio. It calculates how much risk reduction is achieved by combining multiple assets into a portfolio compared to holding individual assets separately.
Diversification is a key strategy in portfolio management, helping to mitigate risk by spreading investments across various asset classes. A higher diversification ratio indicates better risk reduction, while a lower ratio suggests limited benefits from diversification. This tool is essential for assessing portfolio efficiency and making informed investment decisions.
Formula for Diversification Ratio Calculator
The Diversification Ratio can be calculated using the following formula:
Diversification Ratio = Portfolio Volatility (Weighted) / Portfolio Volatility (Actual)Where:
- Diversification Ratio: A measure of risk reduction through diversification.
- Portfolio Volatility (Weighted): The weighted average of the volatilities of individual assets in the portfolio.
- Portfolio Volatility (Actual): The observed overall volatility of the combined portfolio.
A diversification ratio greater than 1 indicates that diversification is effectively reducing risk, whereas a ratio close to 1 suggests minimal diversification benefits.
Commonly Used Terms and Predefined Calculations
Below is a reference table with commonly used terms and approximate diversification ratios for various investment types:
| Investment Type | Expected Diversification Ratio |
|---|---|
| Equity-Only Portfolio | 1.0 – 1.2 |
| Equity & Bonds Mix | 1.3 – 1.7 |
| Global Diversified Portfolio | 1.5 – 2.0 |
| Hedge Funds | 1.2 – 1.5 |
| Real Estate & Stocks | 1.4 – 1.8 |
| Commodities & Equities | 1.3 – 1.6 |
These values are approximate and depend on market conditions, asset correlations, and investment strategies.
Example of Diversification Ratio Calculator
Suppose an investor constructs a portfolio with the following characteristics:
- Weighted average volatility of individual assets: 15%
- Actual observed volatility of the portfolio: 10%
Using the formula:
Diversification Ratio = 15% / 10% = 1.5This means the portfolio has effectively reduced risk by 50% compared to holding individual assets separately.
Most Common FAQs
The diversification ratio helps investors assess the risk reduction achieved through diversification. A higher ratio indicates that the portfolio is benefiting from diversification, leading to lower overall risk.
You can increase your diversification ratio by adding uncorrelated or negatively correlated assets to your portfolio. Investing across different asset classes, industries, and geographical regions can enhance diversification benefits.
A good diversification ratio depends on your investment goals. A ratio above 1.5 generally indicates effective risk reduction, while a ratio close to 1.0 suggests limited diversification benefits.