1. What is Portfolio Diversification?

Portfolio diversification is a risk management strategy that mixes a wide variety of investments within a portfolio. The rationale behind this technique is that a portfolio of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio.

2. How Does the Calculator Work?

The calculator uses the Herfindahl-Hirschman Index formula:

Where:

• \( Weight_i \) — The proportion of each investment in the portfolio (as decimal)
• \( \sum \) — Sum of all squared weights

Interpretation: A higher diversification score indicates better portfolio diversification. Scores closer to 100% represent highly diversified portfolios, while lower scores indicate concentration risk.

3. Importance of Diversification

Details: Proper diversification helps reduce unsystematic risk, smooths out returns over time, and protects against significant losses in any single investment or sector.

4. Using the Calculator

Tips: Enter the weights of your portfolio holdings as decimal values (e.g., 0.25 for 25%), separated by commas. The calculator will automatically normalize the weights and calculate your diversification score.

5. Frequently Asked Questions (FAQ)

Q1: What is a good diversification score?
A: Generally, scores above 80% indicate good diversification, while scores below 60% suggest concentration risk. However, this varies by investment strategy.

Q2: How many holdings should I have for proper diversification?
A: While there's no magic number, most experts recommend 15-30 different holdings across various sectors and asset classes for adequate diversification.

Q3: Does this calculator consider correlation between assets?
A: No, this calculator only measures concentration risk based on weight distribution. For true diversification analysis, correlation between assets should also be considered.

Q4: What's the difference between diversification and the Herfindahl index?
A: The Herfindahl index measures concentration, while diversification is the inverse (1 - Herfindahl). Higher Herfindahl = more concentration, lower diversification.

Q5: Should I aim for 100% diversification?
A: Not necessarily. Some concentration can be beneficial if you have strong convictions about certain investments, but excessive concentration increases risk.