What this lesson is about
Economists rarely agree that anything in finance is truly free. Diversification is the one thing Nobel laureate Harry Markowitz himself called exactly that.
Part 1 of 2
Economists, are, often, hesitant, to, label, anything, in, finance, as, "free.", There's, usually, a, tradeoff, involved., Diversification, stands, out, as, a, true, exception., Harry, Markowitz,, the, economist, who, won, a, Nobel, Prize, for, his, 1952, work, on, portfolio, construction,, called, it, "the, only, free, lunch, in, investing.", Here’s, what, he, meant:, most, methods, to, reduce, risk, come, at, the, cost, of, expected, return., For, example,, holding, more, cash, is, safer, but, earns, less., Diversification, is, unique., Since, different, assets, don’t, always, move, together,, combining, them, can, lower, a, portfolio's, overall, volatility, without, sacrificing, expected, return.
If, you’re, a, first-time, investor,, you, don’t, need, to, buy, 20, different, individual, stocks, to, achieve, this., A, single, low-cost,, broad-market, index, fund, or, ETF, often, holds, hundreds, or, even, thousands, of, underlying, companies., So,, one, small, purchase, can, give, you, real,, immediate, diversification.
Quick check
Nobel laureate Harry Markowitz famously called diversification what?
Markowitz used this phrase to describe diversification's unusual property: it can reduce risk without necessarily requiring you to sacrifice expected return, unlike most risk-reduction strategies.
Part 2 of 2
Quick check
Why is diversification described as "free," when most ways of reducing risk in life or investing cost you something?
Most ways to reduce risk (like holding more cash) also reduce expected return - diversification is unusual because it can lower risk without that same tradeoff, purely from combining assets that don't move identically.
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