One basic theory of investing is diversification. The idea...

One basic theory of investing is diversification. The idea is that you want to have a basket of stocks that do not all "move in the same direction" In other words, if one investment goes down, you don't want a second investment in your portfolio that is also likely to go down. One hallmark of a good portfolio is a low correlation between investments. The following data represent the annual rates of return for various stocks. If you only wish to invest in two of the stocks, which two would you select if your goal is to have low correlation between the two investments?Which two would you select if your goal is to have one stock go up when the other goes down? CAN'T COPY THE TABLE

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Key Concepts

Diversification

Diversification is an investment strategy that involves spreading investments across various assets to reduce exposure to any single risk. By investing in assets that do not move in tandem, investors can minimize the impact of a poor-performing asset on the overall portfolio, thereby enhancing risk-adjusted returns over time.

Correlation

Correlation is a statistical measure that describes the degree to which two securities move in relation to each other. A high correlation indicates that assets move in similar directions, while a low or negative correlation means they move independently or in opposite directions. Understanding correlation helps in selecting assets that, when combined, can reduce overall portfolio volatility.

Negative Correlation

Negative correlation occurs when two assets move in opposite directions; when one asset's value increases, the other's typically decreases. This characteristic is particularly valuable in portfolio construction because it can stabilize returns, as gains in one asset can offset losses in another, further reducing overall investment risk.

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