If there is a key strategy that will give you more confidence when composing your portfolio is through diversification, ie, not focus on a few assets at the time of investment. But it is easy to understand, not so much at the time of application. As a vehicle to measure the risk of your investment will have to be guided by the standard deviation, which captures the volatility, one of the most famous but not the only and, moreover, is not always the best predictors of future risk despite to be the most commonly used as a model. Moreover, the CAPM does not use this measure in itself but only a part of it into the calculation of risk of an asset related to the average of the relevant market, which is called beta.
In this scenario, converge a wide variety of very difficult to categorize factors as liquidity, credit rating, management, the option to redeem an issue, to make it, the risk of seniority or priority of payment in the event of financial insolvency, among others, although it could be assumed that volatility captures all those risks. In other words, the price of a stock should reflect both good and everything bad as everything that takes place behind a business.
Is it easy to calculate the performance of your portfolio? Apparently so, by the weighted average expected returns of each asset within it. This weighting is done taking into account their share in the portfolio. That is, if you have two active and the first has an expected return of 10% while the second 20% and invested 150,000 and $ 50,000, respectively, the performance of the portfolio is: Rp = 10% x 0 75 + 20% x 0.25 = 7.50% + 6.25% = 13.75%. If the calculation of risk is more difficult because not only influences the weighted average of the deviation of each asset, but so does the correlation between them, decreasing the overall risk of the portfolio.
In case you have in your wallet just a company’s stock, 100% will suffer the negative impact of an economic event that affects him adversely at a particular time. Let’s say an oil company that is facing a hard fall in the price of oil, its main source of profit. However, if you decide to diversify intelligently by not buying more shares of that company and acquire others that could have a better performance with the same impact will be materialized immediately and long-term benefits for its decision.
But if you are buying an airline titles, choosing the best company according to standardized criteria for analyzing profitability, solvency, debt, etc, see how it will benefit to the decline in oil prices since this is one of the factors that most directly affects the airlines. If you expected good and bad scenarios occur with almost the same frequency, you can see in the following table the impact on net income of the two companies combined in two different scenarios, the first rise in oil prices and second fall.
If profits are stable, the volatility is zero, in both cases is money. Instead, you can not always have the same fate in an adverse situation with titles of one company while an investor who holds shares in either of the companies mentioned above, have volatile profits. In short, this is what it is to avoid diversifying: what portfolio obtained from the joint becomes stable and, therefore, their contributions on the market. In summary, the variety in the portfolio depends on the behavior of each asset, but also the covariance between them. The matrix of correlations or both are going to show the links between all assets. To gauge whether you are diversified in the right way you need to know the correlation coefficient between two assets and the lower the better. This index can take values between 1 and -1. In the case of two assets have correlation equal to 1, will be perfect, so when the price of one goes up 1%, other 1% also. In the event that is equal to -1, it is perfect but reverse, ie when one goes up the other 1% 1% yield.
The number of assets that can minimize the risk of your portfolio depends on the type and market in which it is operating, it is not the same as having 100 U.S. companies whose most widely used index, the S & P, has up to five times more than companies that have the 14 signatures of Argentina’s Merval which account for 80% of transactions and volume of the stock of that country. The individual risk of each asset can be eliminated or diversifying, is called unsystematic risk. But while there are benefits to this, the risk of a portfolio can not be eliminated completely but minimized, because investors will always stay with the market risk, it is impossible not to assume, given the inherent asset class or country .