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Author: solasis Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 297  
Subject: Re: Is Risk the same as Volatility? Date: 3/13/2000 6:14 PM
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So why does all the advertising and PR say "Reduce risk by diversifying

i don't know. more types of assets more fees?

Is that just advertiser's bunk?

actually no. although it is only one tool in the risk manager toolbox, it is useful in the sense that diversification helps avoid what is known as "gambler's ruin" which, in finance terms, is the one big bet that goes awry and wipes you out completely. in the parlance of your generation - "game over".

note: diversification as taught in academia, primarily relates to diversification between types of financial assets - stocks bonds, cash, real estate, commodities. this type of diversification argument seems geared to reducing short term NAV volatility, which only makes sense if you are highly leveraged (which to be fair, most financial institutions are). but that type of diversification analysis is useless to unleveraged individuals managing their own net worth for long term results.

for those individuals, with a longer term horizon, gambler's ruin arises primarily from the risk of a credit default or bankruptcy of the entity that they may be invested in. e.g. JM. there was a lot of "smart money" invested in Johns Manville, it was a "Dow stock" afterall. this type of risk can be managed with diversification within the same asset class.

however, i do think, as i have stated in the Risk Arbitrage board, that diversification is overstated as a tool. even in the case of minimizing the impact of credit/default risk on a portfolio, the primary risk tool should still be proper due diligence. but due diligence does have it's limitations, dd is not going to protect you from fraud, nor would it have predicted what happened to P&G this past week. therefore i feel that some diversification is necessary. you can never know everything about any one thing, and the future is to a great extent unpredictable, therefore some type of diversification is necessary.

tr
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