Naive diversification

Naive diversification

A strategy whereby an investor simply invests in a number of different assets in the hope that the variance of the expected return on the portfolio is lowered. In contrast, mathematical programming can be used to select the best possible investment weights. Related: Markowitz diversification.

Naive Diversification

Diversification of a portfolio without regard, or with incorrect regard, for the mathematical formulas in the capital asset pricing model. Naive diversification rests on the assumption that simply investing in enough unrelated assets will reduce risk sufficiently to make a profit. Alternately, one may diversify naively by applying the capital asset pricing model incorrectly and finding the wrong efficient portfolio frontier. Such diversification does not necessarily decrease risk at a given expected return, and may in fact increase risk. See also: Markowitz Portfolio Theory.
References in periodicals archive ?
Sometimes investors exhibit "naive diversification" by owning too-similar assets, which does little to reduce risk, says Dan Egan, director of behavioral finance and investments at robo-adviser Betterment: "People will have three or four different S&P 500 funds and think they're diversified but don't look at how correlated they all are."
Thaler (2001), "Naive Diversification Strategies in Defined Contribution Saving Plans," American Economic Review 91(1): 79-98.
Uppal (2009), "Optimal versus Naive Diversification: How Inefficient Is the 1/N Portfolio Strategy?," Review of Financial Studies 22(5): 1915-1953.
Research has found that individuals often view their company stock as a safer investment than a diversified stock fund and follow "naive diversification" strategies such as dividing contributions equally among all available funds, which may needlessly expose them to higher return risk.
Naive diversification requires periodic reassessments of which stocks and other assets to include in a portfolio.
Naive diversification works well for large portfolios but often backfires when applied to a few assets, says Richard Thaler of the University of Chicago, a leading behavioral economist and critic of Gigerenzer's approach.
(1998), "Naive Diversification", Financial Analysts Journal, Vol.54, pp.
As shown in Table 1, all of the institutional property investors adopted naive diversification strategies in their practices.
Specifically, Table 1 shows that 33 (61.1%) of the practitioners were adopting naive diversification strategies.
Thaler, "Naive Diversification Strategies in Defined Contribution Saving Plans"
A strategy of investing that does not take into account the correlation coefficients is considered to be naive diversification. This idea is founded on the premise of efficient markets and is acceptable as long as investors are able to freely move their capital between the investment opportunities.
KEYWORDS: Evaluation; Managers diversification; Real estate portfolio; Constant correlation model; Naive diversification