Using the same method of calculation, we calculate the expected returns and
standard deviations under various portfolio allocations that are presented in
the following table.
It can be seen from the above table that at some
combinations, the risk per unit of return is less than others, and it is also
less than if all the funds were invested in one stock. The reason for this is
the correlation that is less than one. Whenever the correlation between two
stocks is less than 1.0, there would be benefits of diversification. As the
correlation between two assets decreases, there is less of a tendency for stock
returns to move together. There separate movements of each stock serve to reduce
the volatility of a portfolio to a level that is less than that of its
individual components. By diversifying a portfolio across many stocks, it is
possible to create portfolios with higher expected returns without increasing
risk (standard deviation).
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